10-Q 1 wellsreitii201263010-q.htm FORM 10-Q Wells REITII.2012.6.30 10-Q
 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 __________________________________ 
FORM 10-Q
 __________________________________ 
(Mark One)
x
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
for the quarterly period ended June 30, 2012
OR
o
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
for the transition period from ______ to ______
Commission file number 000-51262
WELLS REAL ESTATE INVESTMENT TRUST II, INC.
(Exact name of registrant as specified in its charter)
  __________________________________
Maryland
 
20-0068852
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification Number)
6200 The Corners Parkway
Norcross, Georgia 30092
(Address of principal executive offices)
(Zip Code)
(770) 449-7800
(Registrant's telephone number, including area code)
N/A
(Former name, former address, and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes  x    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
  Yes  x  No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer", "accelerated filer", and "smaller reporting company" in Rule 12b-2 of the Exchange Act (check one).
Large accelerated filer
o
Accelerated filer
o
Non-accelerated filer
x (Do not check if a smaller reporting company)
Smaller reporting company
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes  o    No  x
Number of shares outstanding of the registrant's
only class of common stock, as of July 31, 2012: 546,343,214 shares
 
 
 
 
 


FORM 10-Q
WELLS REAL ESTATE INVESTMENT TRUST II, INC.
TABLE OF CONTENTS
 
 
 
Page No.
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.




Page 2

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements contained in this Form 10-Q of Wells Real Estate Investment Trust II, Inc. ("Wells REIT II," "we," "our" or "us") other than historical facts may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. We intend for all such forward-looking statements to be covered by the applicable safe harbor provisions for forward-looking statements contained in those acts. Such statements include, in particular, statements about our plans, strategies, and prospects and are subject to certain risks and uncertainties, including known and unknown risks, which could cause actual results to differ materially from those projected or anticipated. Therefore, such statements are not intended to be a guarantee of our performance in future periods. Such forward-looking statements can generally be identified by our use of forward-looking terminology such as "may," "will," "expect," "intend," "anticipate," "estimate," "believe," "continue," or other similar words. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date this report is filed with the U.S. Securities and Exchange Commission ("SEC"). We make no representations or warranties (express or implied) about the accuracy of any such forward-looking statements contained in this Form 10-Q, and we do not intend to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.
Any such forward-looking statements are subject to risks, uncertainties, and other factors and are based on a number of assumptions involving judgments with respect to, among other things, future economic, competitive, and market conditions, all of which are difficult or impossible to predict accurately. To the extent that our assumptions differ from actual conditions, our ability to accurately anticipate results expressed in such forward-looking statements, including our ability to generate positive cash flow from operations, make distributions to stockholders, and maintain the value of our real estate properties, may be significantly hindered. See Item 1A in Wells REIT II's Annual Report on Form 10-K for the year ended December 31, 2011 for a discussion of some of the risks and uncertainties that could cause actual results to differ materially from those presented in our forward-looking statements. The risk factors described in our Annual Report are not the only ones we face, but do represent those risks and uncertainties that we believe are material to us. Additional risks and uncertainties not currently known to us or that we currently deem immaterial may also harm our business.


Page 3

PART I.
FINANCIAL INFORMATION
ITEM 1.
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The information furnished in the accompanying consolidated balance sheets, and related consolidated statements of operations, comprehensive income (loss), equity and cash flows, reflects all normal and recurring adjustments that are, in management's opinion, necessary for a fair and consistent presentation of the aforementioned financial statements. The accompanying consolidated financial statements should be read in conjunction with the condensed notes to Wells REIT II's financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations included in this quarterly report on Form 10-Q, and with Wells REIT II's Annual Report on Form 10-K and Form 10-K/A filed for the year ended December 31, 2011. Wells REIT II's results of operations for the three and six months ended June 30, 2012 are not necessarily indicative of the operating results expected for the full year.



Page 4

WELLS REAL ESTATE INVESTMENT TRUST II, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per-share amounts)
 
 
(Unaudited)
 
 
 
June 30,
2012
 
December 31,
2011
Assets:
 
 
 
Real estate assets, at cost:
 
 
 
Land
$
704,336

 
$
704,336

Buildings and improvements, less accumulated depreciation of $570,137 and $514,961, as of June 30, 2012 and December 31, 2011, respectively
3,424,478

 
3,472,971

Intangible lease assets, less accumulated amortization of $348,145 and $343,463, as of June 30, 2012 and December 31, 2011, respectively
357,456

 
391,989

Construction in progress
9,859

 
8,414

Real estate assets held for sale, less accumulated depreciation and amortization of $9,551, as of December 31, 2011
—

 
37,508

Total real estate assets
4,496,129

 
4,615,218

Cash and cash equivalents
60,618

 
39,468

Tenant receivables, net of allowance for doubtful accounts of $592 and $3,728, as of June 30, 2012 and December 31, 2011, respectively
127,915

 
130,549

Prepaid expenses and other assets
29,596

 
32,831

Deferred financing costs, less accumulated amortization of $6,869 and $5,590, as of June 30, 2012 and December 31, 2011, respectively
10,967

 
9,442

Intangible lease origination costs, less accumulated amortization of $244,090 and $236,679, as of June 30, 2012 and December 31, 2011, respectively
208,146

 
231,338

Deferred lease costs, less accumulated amortization of $25,792 and $22,390, as of June 30, 2012 and December 31, 2011, respectively
79,395

 
68,289

Investment in development authority bonds
646,000

 
646,000

Other assets held for sale, less accumulated amortization of $2,260, as of December 31, 2011
—

 
3,432

Total assets
$
5,658,766

 
$
5,776,567

Liabilities:
 
 
 
Line of credit and notes payable
$
1,209,281

 
$
1,221,060

Bonds payable, net of discount of $1,448 and $1,574, as of June 30, 2012 and December 31, 2011, respectively
248,552

 
248,426

Accounts payable, accrued expenses, and accrued capital expenditures
68,508

 
72,349

Due to affiliates
1,587

 
3,329

Deferred income
30,182

 
35,079

Intangible lease liabilities, less accumulated amortization of $82,240 and $74,326, as of June 30, 2012 and December 31, 2011, respectively
80,306

 
89,581

Obligations under capital leases
646,000

 
646,000

Liabilities held for sale
—

 
624

Total liabilities
2,284,416

 
2,316,448

Commitments and Contingencies (Note 6)


 


Redeemable Common Stock
151,455

 
113,147

Equity:
 
 
 
Common stock, $0.01 par value, 900,000,000 shares authorized, 547,259,292 and 546,197,750 shares issued and outstanding as of June 30, 2012 and December 31, 2011, respectively
5,473

 
5,462

Additional paid-in capital
4,892,690

 
4,880,806

Cumulative distributions in excess of earnings (losses)
(1,520,489
)
 
(1,426,550
)
Redeemable common stock
(151,455
)
 
(113,147
)
Other comprehensive income (loss)
(3,324
)
 
84

Total Wells Real Estate Investment Trust II, Inc. stockholders' equity
3,222,895

 
3,346,655

Nonredeemable noncontrolling interests
—

 
317

Total equity
3,222,895

 
3,346,972

Total liabilities, redeemable common stock, and equity
$
5,658,766

 
$
5,776,567

See accompanying notes.


Page 5

WELLS REAL ESTATE INVESTMENT TRUST II, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per-share amounts)
 
 
(Unaudited)
 
(Unaudited)
 
Three months ended
June 30,
 
Six months ended
June 30,
 
2012
 
2011
 
2012
 
2011
Revenues:
 
 
 
 
 
 
 
Rental income
$
118,840

 
$
121,113

 
$
239,326


$
234,732

Tenant reimbursements
24,822

 
24,565

 
50,613


50,472

Hotel income
6,463

 
5,216

 
10,838

 
9,366

Other property income
458

 
2,000

 
2,157

 
2,283

 
150,583

 
152,894

 
302,934

 
296,853

Expenses:
 
 
 
 
 
 
 
Property operating costs
43,150

 
44,116

 
87,684

 
85,804

Hotel operating costs
4,996

 
4,269

 
9,093

 
8,281

Asset and property management fees:
 
 
 
 

 
 
Related-party
9,178

 
9,279

 
18,529

 
18,039

Other
818

 
715

 
1,649

 
1,619

Depreciation
30,232

 
30,099

 
60,357

 
57,541

Amortization
27,959

 
31,302

 
55,009

 
61,468

General and administrative
5,795

 
6,435

 
11,138

 
13,049

Acquisition fees and expenses
—

 
1,194

 
—

 
11,220

 
122,128

 
127,409

 
243,459

 
257,021

Real estate operating income
28,455

 
25,485

 
59,475

 
39,832

Other income (expense):
 
 
 
 
 
 
 
Interest expense
(27,094
)
 
(30,665
)
 
(53,950
)
 
(52,830
)
Interest and other income
10,012

 
10,013

 
20,028

 
22,068

Loss on interest rate swaps
(13
)
 
(7,534
)
 
(89
)
 
(7,445
)
 
(17,095
)
 
(28,186
)
 
(34,011
)
 
(38,207
)
Income (loss) before income tax (expense) benefit
11,360

 
(2,701
)
 
25,464

 
1,625

Income tax (expense) benefit
(398
)
 
168

 
(301
)
 
399

Income (loss) from continuing operations
10,962

 
(2,533
)
 
25,163

 
2,024

Discontinued operations:
 
 
 
 
 
 
 
Operating loss from discontinued operations
(110
)
 
(1,945
)
 
(61
)
 
(4,087
)
Gain on disposition of discontinued operations
62

 
—

 
16,947

 
—

Income (loss) from discontinued operations
(48
)
 
(1,945
)
 
16,886

 
(4,087
)
Net income (loss)
10,914

 
(4,478
)
 
42,049

 
(2,063
)
Less: net income attributable to nonredeemable noncontrolling interests
—

 
(4
)
 
(4
)
 
(8
)
Net income (loss) attributable to the common stockholders of
Wells Real Estate Investment Trust II, Inc.
$
10,914

 
$
(4,482
)
 
$
42,045

 
$
(2,071
)
Per-share information – basic and diluted:

 

 
 
 
 
Income from continuing operations
$
0.02

 
$
0.00

 
$
0.05

 
$
0.00

Income from discontinued operations
$
0.00

 
$
0.00

 
$
0.03

 
$
(0.01
)
Net income attributable to the common stockholders of
Wells Real Estate Investment Trust II, Inc.
$
0.02

 
$
(0.01
)
 
$
0.08

 
$
0.00

Weighted-average common shares outstanding – basic and diluted
546,134

 
542,182

 
545,867

 
541,600

See accompanying notes.


Page 6

WELLS REAL ESTATE INVESTMENT TRUST II, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)

 
(Unaudited)
 
(Unaudited)
 
Three months ended
June 30,
 
Six months ended
June 30,
 
2012
 
2011
 
2012
 
2011
Net income (loss) attributable to the common stockholders of Wells Real Estate
Investment Trust II, Inc.
$
10,914

 
$
(4,482
)
 
$
42,045

 
$
(2,071
)
Market value adjustment to interest rate swap
(4,016
)
 
(1,579
)
 
(3,408
)
 
(827
)
Comprehensive income (loss) attributable to the common stockholders of Wells
Real Estate Investment Trust II, Inc.
6,898

 
(6,061
)
 
38,637

 
(2,898
)
Comprehensive income attributable to noncontrolling interests
—

 
4

 
4

 
8

Comprehensive income (loss)
$
6,898

 
$
(6,057
)
 
$
38,641

 
$
(2,890
)

See accompanying notes.




Page 7

WELLS REAL ESTATE INVESTMENT TRUST II, INC.
CONSOLIDATED STATEMENTS OF EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 2012 (UNAUDITED)
(in thousands, except per-share amounts)

 
Stockholders' Equity
 
 
 
 
 
Common Stock
 
Additional
Paid-In
Capital
 
Cumulative
Distributions
in Excess of
Earnings
 
Redeemable
Common
Stock
 
Other
Comprehensive
Income (Loss)
 
Total Wells Real
Estate Investment
Trust II, Inc.
Stockholders'
Equity
 
Nonredeemable
Noncontrolling
Interests
 
Total
Equity
 
Shares
 
Amount
 
 
 
 
 
 
 
Balance, December 31, 2011
546,198

 
$
5,462

 
$
4,880,806

 
$
(1,426,550
)
 
$
(113,147
)
 
$
84

 
$
3,346,655

 
$
317

 
$
3,346,972

Issuance of common stock
8,796

 
88

 
62,634

 
—

 
—

 
—

 
62,722

 
—

 
62,722

Redemptions of common stock
(7,735
)
 
(77
)
 
(50,755
)
 
—

 
—

 
—

 
(50,832
)
 
—

 
(50,832
)
Increase in redeemable common stock
—

 
—

 
—

 
—

 
(38,308
)
 
—

 
(38,308
)
 
—

 
(38,308
)
Distributions to common stockholders
($0.250 per share)
—

 
—

 
—

 
(135,984
)
 
—

 
—

 
(135,984
)
 
—

 
(135,984
)
Distributions to noncontrolling interests
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(15
)
 
(15
)
Acquisition of noncontrolling interest in consolidated joint ventures
—

 
—

 
5

 
—

 
—

 
—

 
5

 
(306
)
 
(301
)
Net income attributable to the common stockholders of Wells Real Estate Investment Trust II, Inc.
—

 
—

 
—

 
42,045

 
—

 
—

 
42,045

 
—

 
42,045

Net income attributable to noncontrolling interests
—

 
—

 
—

 
 
 
—

 
—

 
—

 
4

 
4

Market value adjustment to interest rate swap
—

 
—

 
—

 
—

 
—

 
(3,408
)
 
(3,408
)
 
—

 
(3,408
)
Balance, June 30, 2012
547,259

 
$
5,473

 
$
4,892,690

 
$
(1,520,489
)
 
$
(151,455
)
 
$
(3,324
)
 
$
3,222,895

 
$
—


$
3,222,895



















Page 8

WELLS REAL ESTATE INVESTMENT TRUST II, INC.
CONSOLIDATED STATEMENTS OF EQUITY
FOR THE SIX MONTHS ENDED June 30, 2011 (UNAUDITED)
(in thousands, except per-share amounts)
 
Stockholders' Equity
 
 
 
 
 
Common Stock
 
Additional
Paid-In
Capital
 
Cumulative
Distributions
in Excess of
Earnings (Losses)
 
Redeemable
Common
Stock
 
Other
Comprehensive
Loss
 
Total Wells Real
Estate Investment
Trust II, Inc.
Stockholders'
Equity
 
Nonredeemable
Noncontrolling
Interests
 
Total
Equity
 
Shares
 
Amount
 
 
 
 
 
 
 
Balance, December 31, 2010
540,907

 
$
5,409

 
$
4,835,088

 
$
(1,212,472
)
 
$
(161,189
)
 
$
(11,139
)
 
$
3,455,697

 
$
347

 
$
3,456,044

Issuance of common stock
6,863

 
69

 
65,296

 
—

 
—

 
—

 
65,365

 
—

 
65,365

Redemptions of common stock
(4,378
)
 
(44
)
 
(40,114
)
 
—

 
—

 
—

 
(40,158
)
 
—

 
(40,158
)
Increase in redeemable common stock
—

 
—

 
—

 
—

 
(61,948
)
 
—

 
(61,948
)
 
—

 
(61,948
)
Distributions to common stockholders
($0.250 per share)
—

 
—

 
—

 
(135,100
)
 
—

 
—

 
(135,100
)
 
—

 
(135,100
)
Distributions to noncontrolling interests
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(20
)
 
(20
)
Net loss attributable to common
stockholders of Wells Real Estate Investment Trust II, Inc.
—

 
—

 
—

 
(2,071
)
 
—

 
—

 
(2,071
)
 
—

 
(2,071
)
Net income attributable to noncontrolling interests
—

 
—

 
—

 
—

 
—

 
—

 
—

 
8

 
8

Market value adjustment to interest rate swap
—

 
—

 
—

 
—

 
—

 
(827
)
 
(827
)
 
—

 
(827
)
Balance, June 30, 2011
543,392

 
$
5,434

 
$
4,860,270

 
$
(1,349,643
)
 
$
(223,137
)
 
$
(11,966
)
 
$
3,280,958

 
$
335

 
$
3,281,293

See accompanying notes.




Page 9

WELLS REAL ESTATE INVESTMENT TRUST II, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
 
(unaudited)
 
Six months ended
June 30,
 
2012
 
2011
Cash Flows from Operating Activities:
 
 
 
Net income (loss)
$
42,049

 
$
(2,063
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Straight-line rental income
(845
)
 
(7,757
)
Depreciation
60,357

 
58,916

Amortization
53,330

 
64,031

(Gain) loss on interest rate swaps
(527
)
 
2,408

Gain on sale of discontinued operations
(16,947
)
 
—

Noncash interest expense
1,897

 
13,988

Changes in assets and liabilities, net of acquisitions:
 
 
 
Decrease (increase) in tenant receivables, net
2,164

 
(1,300
)
Decrease in prepaid expenses and other assets
2,257

 
1,939

(Decrease) increase in accounts payable and accrued expenses
(3,000
)
 
1,555

Decrease in due to affiliates
(1,744
)
 
(2,694
)
(Decrease) increase in deferred income
(5,343
)
 
2,004

Net cash provided by operating activities
133,648

 
131,027

Cash Flows from Investing Activities:
 
 
 
Net proceeds from the sale of real estate
57,747

 
—

Investment in real estate and earnest money paid
(14,439
)
 
(619,171
)
Deferred lease costs paid
(15,839
)
 
(17,452
)
Net cash provided by (used in) investing activities
27,469

 
(636,623
)
Cash Flows from Financing Activities:
 
 
 
Financing costs paid
(3,112
)
 
(6,881
)
Proceeds from lines of credit and notes payable
479,000

 
1,033,500

Repayments of lines of credit and notes payable
(490,998
)
 
(660,477
)
Proceeds from issuance of bonds payable
—

 
248,237

Issuance of common stock
62,722

 
65,365

Redemptions of common stock
(51,256
)
 
(39,298
)
Distributions paid to stockholders
(73,262
)
 
(69,707
)
Distributions paid to stockholders and reinvested in shares of our common stock
(62,722
)
 
(65,393
)
Redemption of noncontrolling interests
(301
)
 
(87
)
Distributions paid to nonredeemable noncontrolling interests
(15
)
 
(20
)
Net cash (used in) provided by financing activities
(139,944
)
 
505,239

Net increase (decrease) in cash and cash equivalents
21,173

 
(357
)
Effect of foreign exchange rate on cash and cash equivalents
(23
)
 
68

Cash and cash equivalents, beginning of period
39,468

 
38,882

Cash and cash equivalents, end of period
$
60,618

 
$
38,593

See accompanying notes.


Page 10

WELLS REAL ESTATE INVESTMENT TRUST II, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2012
(unaudited)
1.
Organization
Wells Real Estate Investment Trust II, Inc. ("Wells REIT II") is a Maryland corporation that has elected to be taxed as a real estate investment trust ("REIT") for federal income tax purposes. Wells REIT II engages in the acquisition and ownership of commercial real estate properties, including properties that are under construction, are newly constructed, or have operating histories. Wells REIT II was incorporated on July 3, 2003 and commenced operations on January 22, 2004. Wells REIT II conducts business primarily through Wells Operating Partnership II, L.P. ("Wells OP II"), a Delaware limited partnership. Wells REIT II is the sole general partner of Wells OP II, and Wells OP II LP, LLC, a wholly owned subsidiary of Wells REIT II, is the sole limited partner of Wells OP II. Therefore, Wells REIT II owns 100% of the equity interests in, and possesses full legal control and authority over, the operations of Wells OP II. Wells OP II acquires, develops, owns, leases, and operates real properties directly, through wholly owned subsidiaries, or through joint ventures. References to Wells REIT II herein shall include Wells REIT II and all subsidiaries of Wells REIT II, direct and indirect, and consolidated joint ventures. Wells Real Estate Advisory Services II, LLC ("WREAS II") serves as the external advisor to Wells REIT II. See Note 8. Related-Party Transactions and Agreements for a discussion of the advisory services provided by WREAS II.
As of June 30, 2012, Wells REIT II owned controlling interests in 69 office properties and one hotel, which include 91 operational buildings. These properties are comprised of approximately 22.3 million square feet of commercial space and are located in 22 states, the District of Columbia, and Moscow, Russia. As of June 30, 2012, 68 of the office properties were wholly owned and the remaining property was owned through a consolidated subsidiary; the office properties were approximately 92.2% leased.
On December 1, 2003, Wells REIT II commenced its initial public offering of up to 785.0 million shares of common stock, of which 185.0 million shares were reserved for issuance through Wells REIT II's dividend reinvestment plan ("DRP"), pursuant to a Registration Statement filed on Form S-11 with the SEC (the "Initial Public Offering"). Except for continuing to offer shares for sale through its DRP, Wells REIT II stopped offering shares for sale under the Initial Public Offering on November 26, 2005. Wells REIT II raised gross offering proceeds of approximately $2.0 billion from the sale of approximately 197.1 million shares under the Initial Public Offering, including shares sold under the DRP through March 2006. On November 10, 2005, Wells REIT II commenced a follow-on offering of up to 300.6 million shares of common stock, of which 0.6 million shares were reserved for issuance under Wells REIT II's DRP, pursuant to a Registration Statement filed on Form S-11 with the SEC (the "Follow-On Offering"). On April 14, 2006, Wells REIT II amended the aforementioned registration statements to offer in a combined prospectus 300.6 million shares registered under the Follow-On Offering and 174.4 million unsold shares related to the DRP originally registered under the Initial Public Offering. Wells REIT II raised gross offering proceeds of approximately $2.6 billion from the sale of approximately 257.6 million shares under the Follow-On Offering, including shares sold under the DRP, through November 2008. Wells REIT II stopped offering shares for sale under the Follow-On Offering on November 10, 2008.
On November 11, 2008, Wells REIT II commenced a third offering of up to 375.0 million shares of common stock pursuant to a Registration Statement filed on Form S-11 with the SEC (the "Third Offering"). Under the Third Offering registration statement, as amended, Wells REIT II offered up to 300.0 million shares of common stock in a primary offering for $10 per share, with discounts available to certain categories of purchasers, and up to 75.0 million shares pursuant to its DRP at a purchase price equal to $9.55. Effective June 30, 2010, Wells REIT II ceased offering shares under the Third Offering. On August 27, 2010, the Third Offering was deregistered under the Form S-11 filing and the shares issuable pursuant to the DRP were registered on Form S-3. As of June 30, 2012, Wells REIT II had raised gross offering proceeds of approximately $1.5 billion from the sale of approximately 150.5 million shares under the Third Offering, including shares sold under the DRP.
As of June 30, 2012, Wells REIT II had raised gross offering proceeds from the sale of common stock under its public offerings of approximately $6.0 billion. After deductions from such gross offering proceeds for selling commissions and dealer-manager fees of approximately $509.5 million, acquisition fees of approximately $116.8 million, other organization and offering expenses of approximately $75.9 million, and common stock redemptions pursuant to our share redemption program of approximately $579.6 million, Wells REIT II had received aggregate net offering proceeds of approximately $4.7 billion. Substantially all of Wells REIT II's net offering proceeds have been invested in real estate.
Wells REIT II's stock is not listed on a public securities exchange. However, Wells REIT II's charter requires that in the event Wells REIT II's stock is not listed on a national securities exchange by October 2015, Wells REIT II must either seek stockholder approval to extend or amend this listing deadline or seek stockholder approval to begin liquidating investments and distributing the resulting proceeds to the stockholders. If Wells REIT II seeks stockholder approval to extend or amend this listing date and does not obtain it, Wells REIT II will then be required to seek stockholder approval to liquidate. In this circumstance, if Wells


Page 11

REIT II seeks and does not obtain approval to liquidate, Wells REIT II will not be required to list or liquidate and could continue to operate indefinitely as an unlisted company.
2.
Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements of Wells REIT II have been prepared in accordance with the rules and regulations of the SEC, including the instructions to Form 10-Q and Article 10 of Regulation S-X, and do not include all of the information and footnotes required by U.S. generally accepted accounting principles ("GAAP") for complete financial statements. In the opinion of management, the statements for these unaudited interim periods presented include all adjustments, which are of a normal and recurring nature, necessary for a fair and consistent presentation of the results for such periods. Results for these interim periods are not necessarily indicative of a full year's results. Wells REIT II's consolidated financial statements include the accounts of Wells REIT II, Wells OP II, and any variable interest entity in which Wells REIT II or Wells OP II was deemed the primary beneficiary. With respect to entities that are not variable interest entities, Wells REIT II's consolidated financial statements shall also include the accounts of any entity in which Wells REIT II, Wells OP II, or their subsidiaries own a controlling financial interest and any limited partnership in which Wells REIT II, Wells OP II, or its subsidiaries own a controlling general partnership interest. All intercompany balances and transactions eliminate in consolidation. For further information, refer to the financial statements and footnotes included in Wells REIT II's Annual Report on Form 10-K for the year ended December 31, 2011.
Fair Value Measurements
Wells REIT II estimates the fair value of its assets and liabilities (where currently required under GAAP) consistent with the provisions of the accounting standard for fair value measurements and disclosures. Under this standard, fair value is defined as the price that would be received upon sale of an asset or paid upon transfer of a liability in an orderly transaction between market participants at the measurement date. While various techniques and assumptions can be used to estimate fair value depending on the nature of the asset or liability, the accounting standard for fair value measurements and disclosures provides the following fair value technique parameters and hierarchy, depending upon availability:
Level 1 – Assets or liabilities for which the identical term is traded on an active exchange, such as publicly traded instruments or futures contracts.
Level 2 – Assets and liabilities valued based on observable market data for similar instruments.
Level 3 – Assets or liabilities for which significant valuation assumptions are not readily observable in the market. Such assets or liabilities are valued based on the best available data, some of which may be internally developed. Significant assumptions may include risk premiums that a market participant would consider.
Real Estate Assets
Wells REIT II is required to make subjective assessments as to the useful lives of its depreciable assets. Wells REIT II considers the period of future benefit of the asset to determine the appropriate useful lives. These assessments have a direct impact on net income. The estimated useful lives of its assets by class are as follows:
 
Buildings
  
40 years
 
Building improvements
  
5-25 years
 
Site improvements
  
15 years
 
Tenant improvements
  
Shorter of economic life or lease term
 
Intangible lease assets
  
Lease term

Evaluating the Recoverability of Real Estate Assets

Wells REIT II continually monitors events and changes in circumstances that could indicate that the carrying amounts of its real estate and related intangible assets, of both operating properties and properties under construction, in which Wells REIT II has an ownership interest, either directly or through investments in joint ventures, may not be recoverable. When indicators of potential impairment are present that suggest that the carrying amounts of real estate assets and related intangible assets (liabilities) may not be recoverable, Wells REIT II assesses the recoverability of these assets by determining whether the respective carrying values will be recovered through the estimated undiscounted future operating cash flows expected from the use of the assets and their eventual disposition. In the event that such expected undiscounted future cash flows do not exceed the carrying values, Wells


Page 12

REIT II adjusts the carrying value of the real estate assets and related intangible assets to the estimated fair values, pursuant to the property, plant, and equipment accounting standard for the impairment or disposal of long-lived assets, and recognizes an impairment loss. Estimated fair values are calculated based on the following information, in order of preference, depending upon availability: (i) recently quoted market prices, (ii) market prices for comparable properties, or (iii) the present value of future cash flows, including estimated salvage value. Certain of our assets may be carried at more than an amount that could be realized in a current disposition transaction.
Assets Held for Sale
Wells REIT II classifies assets as held for sale according to Accounting Standard Codification ("ASC") 360, Accounting for the Impairment or Disposal of Long-Lived Assets ("ASC 360"). According to ASC 360, assets are considered held for sale when the following criteria are met:
•
Management, having the authority to approve the action, commits to a plan to sell the property.
•
The property is available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such property.
•
An active program to locate a buyer and other actions required to complete the plan to sell the property have been initiated.
•
The sale of the property is probable, and transfer of the property is expected to qualify for recognition as a completed sale, within one year.
•
The property is being actively marketed for sale at a price that is reasonable in relation to its current fair value.
•
Actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn.
At such time that a property is determined to be held for sale, its carrying amount is reduced to the lower of its depreciated book value or its estimated fair value, less costs to sell, and depreciation is no longer recognized. As of December 31, 2011, Emerald Point and 5995 Opus Parkway were classified as held for sale at their respective depreciated book values (see Note 9. Assets Held for Sale and Discontinued Operations for additional detail). Both 5995 Opus Parkway and Emerald Point were sold in January 2012.
Intangible Assets and Liabilities Arising from In-Place Leases where Wells REIT II is the Lessor
Upon the acquisition of real properties, Wells REIT II allocates the purchase price of properties to tangible assets, consisting of land, building, site improvements, and identified intangible assets and liabilities, including the value of in-place leases, based in each case on Wells REIT II's estimate of their fair values in accordance with ASC 820 (see Fair Value Measurements section above for additional detail). As of June 30, 2012 and December 31, 2011, Wells REIT II had the following gross intangible in-place lease assets and liabilities (in thousands):
 
 
Intangible Lease Assets
 
Intangible
Lease
Origination
Costs
 
Intangible
Below-Market
In-Place Lease
Liabilities
 
Above-Market
In-Place
Lease Assets
 
Absorption
Period Costs
 
June 30, 2012
Gross
$
98,627

 
$
496,301

 
$
452,236

 
$
162,546

 
Accumulated Amortization
$
(63,029
)
 
$
(275,169
)
 
$
(244,090
)
 
$
(82,240
)
 
Net
$
35,598

 
$
221,132

 
$
208,146

 
$
80,306

December 31, 2011
Gross
$
109,457

 
$
515,322

 
$
468,017

 
$
163,907

 
Accumulated Amortization
$
(68,706
)
 
$
(265,844
)
 
$
(236,679
)
 
$
(74,326
)
 
Net
$
40,751

 
$
249,478

 
$
231,338

 
$
89,581








Page 13

For the six months ended June 30, 2012 and the year ended December 31, 2011, Wells REIT II recognized the following amortization of intangible lease assets and liabilities (in thousands):
 
Intangible Lease Assets
 
Intangible
Lease
Origination
Costs
 
Intangible
Below-Market
In-Place Lease
Liabilities
Above-Market
In-Place
Lease Assets
 
Absorption
Period Costs
 
For the three months ended June 30, 2012
$
2,333

 
$
13,348

 
$
10,939

 
$
4,228

For the three months ended June 30, 2011
$
3,854

 
$
17,101

 
$
12,782

 
$
4,512

For the six months ended June 30, 2012
$
4,865

 
$
27,031

 
$
22,283

 
$
8,524

For the six months ended June 30, 2011
$
7,664

 
$
32,374

 
$
25,383

 
$
8,340

The remaining net intangible assets and liabilities as of June 30, 2012 will be amortized as follows (in thousands):
 
Intangible Lease Assets
 
Intangible
Lease
Origination
Costs
 
Intangible
Below-Market
In-Place Lease
Liabilities
Above-Market
In-Place
Lease Assets
 
Absorption
Period Costs
 
For the six months ended December 31, 2012
$
4,361

 
$
24,498

 
$
20,871

 
$
8,180

For the years ending December 31:


 

 

 

2013
7,620

 
45,321

 
40,109

 
16,061

2014
6,578

 
40,283

 
37,151

 
15,629

2015
5,993

 
34,965

 
33,425

 
13,217

2016
5,718

 
24,688

 
25,654

 
8,209

2017
2,418

 
16,227

 
17,167

 
5,715

Thereafter
2,910

 
35,150

 
33,769

 
13,295

 
$
35,598

 
$
221,132

 
$
208,146

 
$
80,306

Intangible Assets and Liabilities Arising from In-Place Leases where Wells REIT II is the Lessee
In-place ground leases where Wells REIT II is the lessee may have value associated with effective contractual rental rates that are above or below market rates at the time of execution or assumption. Such values are calculated based on the present value (using a discount rate that reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place lease and (ii) management's estimate of fair market lease rates for the corresponding in-place lease at the time of execution or assumption, measured over a period equal to the remaining terms of the leases. The capitalized above-market and below-market in-place lease values are recorded as intangible lease liabilities and assets, respectively, and are amortized as an adjustment to property operating cost over the remaining term of the respective leases. Wells REIT II had gross below-market lease assets of approximately $110.7 million as of June 30, 2012 and December 31, 2011, and recognized amortization of these assets of approximately $0.5 million for the three months ended June 30, 2012 and 2011, and $1.0 million for the six months ended June 30, 2012 and 2011.
As of June 30, 2012, the remaining net below-market lease asset will be amortized as follows (in thousands):
For the year ending December 31:
 
2012
$
1,035

2013
2,069

2014
2,069

2015
2,069

2016
2,069

2017
2,069

Thereafter
89,346

 
$
100,726



Page 14

Interest Rate Swap Agreements
Wells REIT II enters into interest rate swap contracts to mitigate its interest rate risk on the related financial instruments. Wells REIT II does not enter into derivative or interest rate transactions for speculative purposes; however, certain of its derivatives may not qualify for hedge accounting treatment. Wells REIT II records the fair value of its interest rate swaps either as prepaid expenses and other assets or as accounts payable, accrued expenses, and accrued capital expenditures. Changes in the fair value of the effective portion of interest rate swaps that are designated as cash flow hedges are recorded as other comprehensive income (loss), while changes in the fair value of the ineffective portion of a hedge, if any, is recognized currently in earnings. Changes in the fair value of interest rate swaps that do not qualify for hedge accounting treatment are recorded as gain (loss) on interest rate swaps. Amounts received or paid under interest rate swap agreements are recorded as interest expense for contracts that qualify for hedge accounting treatment and as gain (loss) on interest rate swaps for contracts that do not qualify for hedge accounting treatment.
The following tables provide additional information related to Wells REIT II's interest rate swaps as of June 30, 2012 and December 31, 2011 (in thousands):
 
 
 
 
Estimated Fair Value as of
Instrument Type
 
Balance Sheet Classification
 
June 30,
2012
 
December 31,
2011
Derivatives designated as hedging instruments:
 
 
 
 
 
 
Interest rate contracts
 
Accounts payable
 
$
(3,408
)
 
$
—

Derivatives not designated as hedging instruments:
 
 
 
 
 
 
Interest rate contracts
 
Accounts payable
 
$
(1,195
)
 
$
(1,722
)

Wells REIT II applied the provisions of the accounting standard for fair value measurements and disclosures in recording its interest rate swaps at fair value. The fair values of the interest rate swap, classified under Level 2, were determined using a third-party proprietary model that is based on prevailing market data for contracts with matching durations, current and anticipated London Interbank Offered Rate ("LIBOR") information, and reasonable estimates about relevant future market conditions. Wells REIT II has determined that the fair value, as determined by the third party, is reasonable. The fair value of Wells REIT II's interest rate swaps were $(4.6) million and $(1.7) million at June 30, 2012 and December 31, 2011, respectively.
 
Six months ended
June 30,
 
2012
 
2011
Market value adjustment to interest rate swaps designated as hedging instruments and included in
  other comprehensive income
$
(3,408
)
 
$
(827
)
Loss on interest rate swaps recognized through earnings
$
(89
)
 
$
(7,445
)
During the periods presented, there was no hedge ineffectiveness required to be recognized into earnings on the interest rate swaps that qualified for hedge accounting treatment.
Income Taxes
Wells REIT II has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the "Code"), and has operated as such beginning with its taxable year ended December 31, 2003. To qualify as a REIT, Wells REIT II must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of its REIT taxable income, as defined by the Code, to its stockholders. As a REIT, Wells REIT II generally is not subject to income tax on income it distributes to stockholders. Wells REIT II's stockholder distributions typically exceed its taxable income due to the inclusion of non-cash expenses, such as depreciation, in taxable income. As a result, Wells REIT II typically does not incur federal income taxes other than as described in the following paragraph. Wells REIT II is, however, subject to certain state and local taxes related to the operations of properties in certain locations, which have been provided for in the accompanying consolidated financial statements.
Wells TRS II, LLC ("Wells TRS"); Wells KCP TRS, LLC ("Wells KCP TRS"); and Wells Energy TRS, LLC ("Wells Energy TRS") (collectively, the "Wells TRS Entities") are wholly owned subsidiaries of Wells REIT II, are organized as Delaware limited liability companies, and operate, among other things, a full-service hotel. Wells REIT II has elected to treat the Wells TRS Entities as taxable REIT subsidiaries. Wells REIT II may perform certain additional, noncustomary services for tenants of its buildings through the Wells TRS Entities; however, any earnings related to such services are subject to federal and state income taxes. In addition,


Page 15

for Wells REIT II to continue to qualify as a REIT, Wells REIT II must limit its investments in taxable REIT subsidiaries to 25% of the value of the total assets. The Wells TRS Entities' deferred tax assets and liabilities represent temporary differences between the financial reporting basis and the tax basis of assets and liabilities based on the enacted rates expected to be in effect when the temporary differences reverse. Wells REIT II records interest and penalties related to uncertain tax positions as general and administrative expense in the accompanying consolidated statements of operations.
3.
Real Estate Acquisitions
Wells REIT II did not acquire any real properties during the six months ended June 30, 2012. Wells REIT II acquired the Market Square Buildings on March 7, 2011. The following unaudited pro forma statements of operations presented for the three and six months ended June 30, 2011 have been prepared for Wells REIT II to give effect to the acquisition of the Market Square Buildings as if the acquisition occurred on January 1, 2011. The unaudited pro forma financial information has been prepared for informational purposes only and is not necessarily indicative of future results or of actual results that would have been achieved had the acquisition of the Market Square Buildings acquisition been consummated as of January 1, 2011 (in thousands).
 
Three months ended
June 30, 2011
 
Six months ended
June 30, 2011
Revenues
$
154,462

 
$
308,710

Net loss attributable to common stockholders
$
(4,482
)
 
$
(4,874
)
4.
Line of Credit and Notes Payable
As of June 30, 2012 and December 31, 2011, Wells REIT II had the following line of credit and notes payable indebtedness outstanding (excluding bonds payable, see Note 5. Bonds Payable) in thousands:
Facility
 
June 30,
2012
 
December 31,
2011
$450.0 Million Term Loan
 
$
410,000

 
$
—

Market Square Buildings mortgage note
 
325,000

 
325,000

100 East Pratt Street Building mortgage note
 
105,000

 
105,000

JPMorgan Chase Credit Facility
 
97,000

 
484,000

Wildwood Buildings mortgage note
 
90,000

 
90,000

263 Shuman Boulevard Building mortgage note
 
49,000

 
49,000

SanTan Corporate Center mortgage notes
 
39,000

 
39,000

One West Fourth Street Building mortgage note
 
38,396

 
39,555

Three Glenlake Building mortgage note
 
26,110

 
25,958

215 Diehl Road Building mortgage note
 
21,000

 
21,000

544 Lakeview Building mortgage note
 
8,775

 
8,707

Highland Landmark Building mortgage note
 
—

 
33,840

Total indebtedness
 
$
1,209,281

 
$
1,221,060

On January 10, 2012, Wells REIT II used cash on hand and proceeds from the JPMorgan Chase credit facility to fully repay the Highland Landmark Building mortgage note of $33.8 million at its maturity.
On February 3, 2012, Wells REIT II closed on a four-year, unsecured term loan with a syndicate of banks led by JPMorgan Chase Bank N.A. (the "$450.0 Million Term Loan"), which yielded initial gross proceeds of $375.0 million and additional gross proceeds of $40.0 million in the second quarter for total outstanding borrowings of $410.0 million as of June 30, 2012. The $450.0 Million Term Loan bears interest at LIBOR, plus an applicable base margin; however, Wells REIT II effectively fixed the interest rate (assuming no change in our corporate credit rating) at 2.64% per annum with an interest rate swap executed contemporaneously with the loan. The $450.0 Million Term Loan matures on February 3, 2016 provided that certain conditions are met prior to that date. Furthermore, provided that certain additional conditions are met prior to, and at, maturity, the $450.0 Million Term Loan shall become eligible for a one-year extension upon paying an extension fee equal to 0.15% of the outstanding balance.


Page 16

The $450.0 Million Term Loan includes two options to increase total borrowings to a maximum of $450.0 million (the "Term Loan Accordion Options"), both of which have been exercised upon increasing total borrowings from $375.0 million to $410.0 million in April 2012, and increasing total borrowings from $410.0 million to $450.0 million in July 2012. Contemporaneous with the closing of each new borrowing, Wells REIT II effectively fixed the interest rate (assuming no change in our corporate credit rating) on each accordion option with an interest rate swap agreement, which together caused the weighted average effective borrowing rate on aggregate borrowings under the $450.0 Million Term Loan includes two options to increase total borrowings Term loan to decrease slightly from 2.64% per annum to 2.63% per annum. The proceeds from the $450.0 Million Term Loan, including the Term Loan Accordion Options, were used to repay temporary borrowings, and thereby create additional borrowing capacity, under the JPMorgan Chase Credit Facility. The majority of these temporary borrowings were drawn to settle mortgage loans during the second half of 2011 and during 2012.
The estimated fair value of Wells REIT II's line of credit and notes payable as of June 30, 2012 and December 31, 2011 was approximately $1,248.3 million and $1,282.6 million, respectively. Wells REIT II estimated the fair value of its line of credit by obtaining estimates for similar facilities from multiple market participants as of the respective reporting dates. Therefore, the fair values determined are considered to be based on observable market data for similar instruments (Level 2). The fair values of all other debt instruments were estimated based on discounted cash flow analyses using the current incremental borrowing rates for similar types of borrowing arrangements as of the respective reporting dates. The discounted cash flow method of assessing fair value results in a general approximation of value, and such value may never actually be realized. During the six months ended June 30, 2012 and 2011, Wells REIT II made interest payments of approximately $24.5 million and $21.1 million, respectively. There was no interest capitalized in either period. As of June 30, 2012, Wells REIT II believes it was in compliance with the restrictive covenants on its $450.0 Million Term Loan, outstanding line of credit, and notes payable obligations.
5.
Bonds Payable
In 2011, Wells REIT II issued $250.0 million of its 7-year, unsecured 5.875% senior notes at 99.295 percent of their face value (the "2018 Bonds Payable").Wells REIT II received proceeds from the 2018 Bonds Payable, net of fees, of $246.7 million. The 2018 Bonds Payable require semi-annual interest payments in April and October based on a contractual annual interest rate of 5.875%, which is subject to adjustment in certain circumstances. In the accompanying consolidated balance sheets, the 2018 Bonds Payable are shown net of the initial issuance discount of approximately $1.8 million, which is amortized to interest expense over the term of the 2018 Bonds Payable using the effective interest method. The principal amount of the 2018 Bonds Payable is due and payable on the maturity date. Interest payments of $7.3 million were made on the 2018 Bonds Payable during the six months ended June 30, 2012. As of June 30, 2012, Wells REIT II believes it was in compliance with the restrictive covenants on the 2018 Bonds Payable.
The estimated fair value of the 2018 Bonds Payable as of June 30, 2012 and December 31, 2011 was approximately $251.1 million. The fair value of the 2018 Bonds Payable was estimated based on discounted cash flow analyses using the current incremental borrowing rates for similar types of borrowing as the 2018 Bonds Payable arrangements as of the respective reporting dates (Level 2). The discounted cash flow method of assessing fair value results in a general approximation of value, and such value may never actually be realized.
6.
Commitments and Contingencies
Commitments Under Existing Lease Agreements
Certain lease agreements include provisions that, at the option of the tenant, may obligate Wells REIT II to expend capital to expand an existing property or provide other expenditures for the benefit of the tenant. As of June 30, 2012, no tenants have exercised such options that had not been materially satisfied.
Litigation
Wells REIT II is subject to various legal proceedings, claims and administrative proceedings arising in the ordinary course of business, some of which are expected to be covered by liability insurance. Management makes assumptions and estimates concerning the likelihood and amount of any reasonably possible loss relating to these matters using the latest information available. Wells REIT II records a liability for litigation if an unfavorable outcome is probable and the amount of loss or range of loss can be reasonably estimated. If an unfavorable outcome is probable and a reasonable estimate of the loss is a range, Wells REIT II accrues the best estimate within the range. If no amount within the range is a better estimate than any other amount, Wells REIT II accrues the minimum amount within the range. If an unfavorable outcome is probable but the amount of the loss cannot be reasonably estimated, Wells REIT II discloses the nature of the litigation and indicates that an estimate of the loss or range of loss cannot be made. If an unfavorable outcome is reasonably possible and the estimated loss is material, Wells REIT II discloses the nature and estimate of the possible loss of the litigation. Wells REIT II does not disclose information with respect to litigation


Page 17

where an unfavorable outcome is considered to be remote. Based on current expectations, such matters, both individually and in the aggregate, are not expected to have a material adverse effect on the liquidity, results of operations, business or financial condition of Wells REIT II. Wells REIT II is not currently involved in any legal proceedings of which management would consider the outcome to be reasonably likely to have a material adverse effect on the results of operations or financial condition of Wells REIT II.
7.
Supplemental Disclosures of Noncash Investing and Financing Activities
Outlined below are significant noncash investing and financing activities for the six months ended June 30, 2012 and 2011 (in thousands): 
 
Six months ended
June 30,
 
2012
 
2011
Other assets assumed upon acquisition of properties
$
—

 
$
2,821

Other liabilities assumed upon acquisition of property
$
—

 
$
3,289

Notes payable assumed at acquisition
$
—

 
$
8,607

Noncash interest accruing to notes payable
$
152

 
$
7,831

Market value adjustment to interest rate swaps that qualifies for hedge accounting treatment
$
(3,408
)
 
$
(827
)
Accrued capital expenditures and deferred lease costs
$
5,432

 
$
6,952

Accrued deferred financing costs
$
10

 
$
99

Accrued redemptions of common stock
$
1,216

 
$
874

Commissions on stock sales and related dealer-manager fees due to affiliate
$
—

 
$
13

Increase in redeemable common stock
$
38,308

 
$
61,948

 
8.
Related-Party Transactions and Agreements
Advisory Agreement
Wells REIT II is party to an agreement with WREAS II, under which WREAS II is required to perform certain key functions on behalf of Wells REIT II, including, among others, the investment of capital proceeds and management of day-to-day operations (the "Advisory Agreement"). WREAS II has executed master services agreements with Wells Capital, Inc. ("Wells Capital") and Wells Management Company, Inc. ("Wells Management") whereby WREAS II may retain the use of Wells Capital's and Wells Management's employees as necessary to perform the services required under the Advisory Agreement, and in return, shall reimburse Wells Capital and Wells Management for the associated personnel costs. Further, under the terms of the Advisory Agreement, Wells Real Estate Funds, Inc. ("WREF") guarantees WREAS II's performance of services and any amounts payable to Wells REIT II in connection therewith. The agreement may be terminated, without cause or penalty, by either party upon providing 60 days' prior written notice to the other party.
Under the terms of the Advisory Agreement effective through June 30, 2012, Wells REIT II incurred fees and reimbursements payable to WREAS II and its affiliates for services as described below:
•
Asset management fees are incurred monthly at one-twelfth of 0.625% of the lesser of (i) gross cost, as defined, of all properties of Wells REIT II (other than those that fail to meet specified occupancy thresholds) and investments in joint ventures, or (ii) the aggregate value of Wells REIT II's interest in the properties and joint ventures as established with the most recent asset-based valuation, until the monthly payment equals $2.7 million (or $32.5 million annualized), as of the last day of each preceding month. For the first three months of 2011, Wells REIT II generally paid monthly asset management fees equal to one-twelfth of 0.625% of the cost of all of Wells REIT II's properties (other than those that fail to meet specified occupancy thresholds) and its investments in joint ventures; from April 2011 through June 2012, asset management fees were capped at $2.7 million per month (or $32.5 million annualized) following the March 2011 acquisition of the Market Square Buildings. With respect to (ii) above, Wells REIT II published its first net asset-based valuation (per share) on November 8, 2011, which has not impacted asset management fees incurred to date due to continued applicability of the $2.7 million per month ($32.5 million per annum) cap described above.




Page 18

•
Reimbursement for all costs and expenses WREAS II and its affiliates incur in fulfilling its duties as the asset portfolio manager, generally including (i) wages and salaries and other employee-related expenses of WREAS II and its affiliates' employees, who perform a full range of real estate services for Wells REIT II, including management, administration, operations, and marketing, and are billed to Wells REIT II based on the amount of time spent on Wells REIT II by such personnel, provided that such expenses are not reimbursed if incurred in connection with services for which WREAS II and its affiliates receive a disposition fee (described below) or an acquisition fee, and (ii) amounts paid for IRA custodial service costs allocated to Wells REIT II accounts. The Advisory Agreement limits the amount of reimbursements to the Advisor of "portfolio general and administrative expenses" and "personnel expenses," as defined, to the extent they would exceed $18.7 million and $10.5 million, respectively, for the period from January 1, 2011 through December 31, 2011 and $9.0 million and $5.0 million, respectively, for the period from January 1, 2012 through June 30, 2012.
•
Through July 31, 2011, acquisition fees were incurred at 2.0% of gross offering proceeds, subject to certain limitations. Effective August 1, 2011, acquisition fees have been incurred at 1.0% of property purchase price (excluding acquisition expenses); however, in no event may total acquisition fees for the calendar year exceed 2.0% of total gross offering proceeds. Wells REIT II also reimburses WREAS II and its affiliates for expenses it pays to third parties in connection with acquisitions or potential acquisitions.
•
For any property sold by Wells REIT II, other than part of a "bulk sale" of assets, as defined, a disposition fee equal to 1.0% of the sales price, with the limitation that the total real estate commissions (including such disposition fee) for any Wells REIT II property sold may not exceed the lesser of (i) 6.0% of the sales price of each property or (ii) the level of real estate commissions customarily charged in light of the size, type, and location of the property.
•
Reimbursement of organization and offering costs paid by WREAS II and its affiliates on behalf of Wells REIT II, not to exceed 2.0% of gross offering proceeds.
•
Incentive fee of 10.0% of net sales proceeds remaining after stockholders have received distributions equal to the sum of the stockholders' invested capital, plus an 8% per annum cumulative return of invested capital, which fee is payable only if the shares of common stock of Wells REIT II are not listed on an exchange.
•
Listing fee of 10% of the amount by which the market value of the stock plus distributions paid prior to listing exceeds the sum of 100% of the invested capital, plus an 8% per annum cumulative return on invested capital, which fee will be reduced by the amount of any incentive fees paid as described in the preceding bullet.
Property Management, Leasing and Construction Agreement
Wells REIT II and WREAS II were party to a master property management, leasing, and construction agreement (the "Property Management Agreement") during 2011 and the first six months of 2012, under which WREAS II received the following fees and reimbursements in consideration for supervising the management, leasing, and construction of certain Wells REIT II properties:
•
Property management fees in an amount equal to a percentage negotiated for each property managed by WREAS II of the gross monthly income collected for that property for the preceding month;
•
Leasing commissions for new, renewal, or expansion leases entered into with respect to any property for which Wells Management serves as leasing agent equal to a percentage as negotiated for that property of the total base rental and operating expenses to be paid to Wells REIT II during the applicable term of the lease, provided, however, that no commission shall be payable as to any portion of such term beyond 10 years;
•
Initial lease-up fees for newly constructed properties under the agreement, generally equal to one month's rent;
•
Fees equal to a specified percentage of up to 5.0% of all construction build-out funded by Wells REIT II, given as a leasing concession, and overseen by WREAS II; and
•
Other fees as negotiated with the addition of each specific property covered under the agreement.
•
Wells Management, an affiliate of WREAS II, guaranteed the performance of all of WREAS II's obligations under the Property Management Agreement.


Page 19

Related-Party Costs
Pursuant to the terms of the agreements described above, Wells REIT II incurred the following related-party costs for the three and six months ended June 30, 2012 and 2011, respectively (in thousands):
 
Three months ended
June 30,
 
Six months ended
June 30,
 
2012
 
2011
 
2012
 
2011
Asset management fees
$
8,125

 
$
8,124

 
$
16,250

 
$
15,844

Administrative reimbursements, net(1)
2,839

 
2,938

 
5,591

 
5,779

Property management fees
1,053

 
1,168

 
2,279

 
2,216

Acquisition fees
—

 
656

 
—

 
1,307

Construction fees(2)
20

 
13

 
61

 
49

Total
$
12,037

 
$
12,899

 
$
24,181

 
$
25,195

(1) 
Administrative reimbursements are presented net of reimbursements from tenants of approximately $1.1 million for the three months ended June 30, 2012 and 2011 and approximately $2.2 million and $1.8 million for the six month ended June 30, 2012 and 2011, respectively.
(2) 
Construction fees are capitalized to real estate assets as incurred.
Wells REIT II incurred no related-party commissions, dealer-manager fees, other offering costs, incentive fees, listing fees, disposition fees or leasing commissions during the three and six months ended June 30, 2012 and 2011, respectively.
Due to Affiliates
The detail of amounts due to WREAS II and its affiliates is provided below as of June 30, 2012 and December 31, 2011 (in thousands): 
 
June 30,
2012
 
December 31,
2011
Administrative reimbursements
$
1,234

 
$
217

Asset and property management fees
353

 
3,112

Total
$
1,587

 
$
3,329

Future Advisory and Transition Agreements
Wells REIT II's board of directors has been in negotiations with WREF regarding transitioning Wells REIT II from its current externally advised management structure to a self-managed platform. As a result of these negotiations, on June 28, 2012, Wells REIT II entered into the following agreements with WREF and its affiliates, which are effective July 1, 2012:
Initial Term Advisory Agreement
The initial term advisory agreement extends the Advisory Agreement through December 31, 2012 and includes terms substantially the same as those currently in effect (the "Initial Term Advisory Agreement"), except for the following changes:
•
Fees otherwise due under the terms of the agreement were reduced by $83,333 per month for six months for a total savings to Well REIT II of approximately $500,000.
•
Wells REIT II will pay $21,000 per month for occupancy costs for WREAS II's dedicated office space.
•
Stockholder and communications services and expense reimbursements related thereto were separated out of the Advisory Agreement and covered under the Investor Services Agreement discussed below.
•
Property management oversight and expense reimbursements related thereto were separated out of the Advisory Agreement and covered under the Property Management Agreement discussed below.
Upon expiration of the Initial Term Advisory Agreement, Wells REIT II expects to enter a subsequent advisory agreement (the "Renewal Advisory Agreement") for another year. The terms of the Renewal Advisory Agreement would be the same as under the Initial Term Advisory Agreement except the fee reduction would be changed from $83,333 per month to $166,667 per month for


Page 20

a total annual savings to Wells REIT II of approximately $2,000,000. Wells REIT II is not obligated to enter the Renewal Advisory Agreement but must do so to exercise the WREAS II Assignment Option, which is described below.
Investor Services Agreement
The Investor Services Agreement requires WREF to provide the stockholder and communications services currently provided under the Advisory Agreement to Wells REIT II. As the sole consideration for these services, Wells REIT II will reimburse WREF for expenses incurred in connection with carrying out such services, subject to the cap on "Portfolio General and Administrative Expenses" and "Personnel Expenses" included in the advisory agreement and, thus, will not incur a separate fee. The Investor Services Agreement is terminable on 60 days' notice without penalty and expires on December 31,2012. If Wells REIT II enters the Renewal Advisory Agreement, then a renewal investor services agreement will be entered upon expiration of the Investor Services Agreement on the same terms and will be coterminous with the Renewal Advisory Agreement.
New Property Management Agreement
The New Property Management Agreement is substantially the same as the Property Management described above except that Wells Management is party to the agreement instead of WREAS II and will also provide Wells REIT II with portfolio-level property management services currently provided under the Advisory Agreement, which shall be subject to the cap on "Portfolio General and Administrative Expenses" and "Personnel Expenses" included in the advisory agreement. The Property Management Agreement is terminable on 60 days' notice without penalty and expires on December 31, 2012.
Transition Services and Consulting Services Agreements
The Transition Services Agreement is between Wells REIT II, WREAS II, and WREF and expires on December 31, 2013. Pursuant to the Transition Services Agreement, (i) WREF will transfer the assets and employees necessary to provide the services under the advisory agreement (other than investor services and property management) to WREAS II by January 1, 2013; provided that if WREF is not able to transfer certain assets by then, WREF must use its commercially reasonable best efforts to transfer such delayed assets as promptly as possible, but no later than June 30, 2013; and (ii) Wells REIT II will have the option to acquire WREAS II at any time during 2013 (the "WREAS II Assignment Option"). No payment is associated with the assignment; however, Wells REIT II is required to pay WREF for the work required to transfer sufficient employees, proprietary systems and processes, and assets to WREAS II to prepare for a successful transition to self-management. Accordingly, pursuant to the Transition Services Agreement, Wells REIT II is obligated to pay WREF a total of $6,000,000 payable in 12 monthly installments of $500,000 commencing on July 31, 2012. In addition, Wells REIT II and WREF will each pay half of any out-of-pocket and third-party costs and expenses incurred in connection with providing the services provided that Wells REIT II's obligation to reimburse WREF for such expenses is limited to $250,000 in the aggregate. The Transition Services Agreement is terminable if there is a material breach by WREF that is not cured, or if WREF is in an insolvency proceeding. Otherwise, if Wells REIT II elects to terminate the agreement early, all remaining payments due under the agreement will be accelerated such that WREF receives $6,000,000 in the aggregate.
Should Wells REIT II exercise the WREAS II Assignment Option, the Renewal Advisory Agreement and renewal investor services agreement would terminate and Wells REIT II must enter a consulting services agreement with WREF (the "Consulting Services Agreement") and may negotiate a new investor services agreement. Under the Consulting Services Agreement, WREF would provide consulting services with respect to the same matters that WREAS II and its affiliates would provide advisory services under the Renewal Advisory Agreement. Payments under the Consulting Services Agreement would equal the remaining payments due under the Renewal Advisory Agreement and Investor Services Agreement had they not been terminated.
Operational Dependency
Wells REIT II has engaged WREAS II, WREF, and Wells Management to provide certain services that are essential to Wells REIT II, including asset management services, supervision of the property management and leasing of some properties owned by Wells REIT II, asset acquisition and disposition services, as well as other administrative responsibilities for Wells REIT II, including accounting services, stockholder communications, and investor relations. Further, WREAS II has engaged Wells Capital to retain the use of its employees to carry out certain of the services listed above. As a result of these relationships, Wells REIT II's operations are dependent upon WREAS II, WREF, Wells Capital, and Wells Management.
WREAS II, Wells Capital, and Wells Management are owned and controlled by WREF. Historically, the operations of WREAS II, Wells Capital, and Wells Management have represented substantially all of the business of WREF. Accordingly, Wells REIT II focuses on the financial condition of WREF when assessing the financial condition of WREAS II, Wells Capital, and Wells Management. In the event that WREF were to become unable to meet its obligations as they become due, Wells REIT II might be required to find alternative service providers. Future net income generated by WREF will be largely dependent upon the amount of fees earned by WREF's subsidiaries based on, among other things, the level of investor proceeds raised and the volume of future acquisitions and dispositions of real estate assets by other WREF-sponsored real estate programs, as well as distribution income


Page 21

earned from equity interests in another REIT previously sponsored by Wells Capital. As of June 30, 2012, Wells REIT II has no reason to believe that WREF does not have access to adequate liquidity and capital resources, including cash flow generated from operations, cash on hand, and other investments and borrowing capacity necessary to meet its obligations as they become due. Modifying Wells REIT II's service agreements, as described in the preceding section Proposed Agreements with Wells Real Estate Funds and its Affiliates, could impact WREF's future net income and future access to liquidity and capital resources.
9.
Assets Held for Sale and Discontinued Operations
Assets Held for Sale
In accordance with GAAP, assets that meet certain criteria for disposal are required to be classified as "held for sale" in the accompanying balance sheets. As of December 31, 2011, Emerald Point, a four-story office building in Dublin, California, and 5995 Opus Parkway, a five-story office building in Minnetonka, Minnesota, were subject to firm sales contracts and, thus, classified as "held for sale" in the accompanying consolidated balance sheet as of December 31, 2011. The Emerald Point sale closed on January 9, 2012 for $37.3 million, exclusive of transaction costs, and the 5995 Opus Parkway sale closed on January 12, 2012 for $22.8 million, exclusive of transaction costs.
The major classes of assets and liabilities classified as held for sale as of December 31, 2011 is provided below (in thousands):
 
December 31,
2011
Real estate assets held for sale:
 
Real estate assets, at cost:
 
Land
$
11,536

Buildings and improvements, less accumulated depreciation of $6,509
25,972

Intangible lease assets, less accumulated amortization of $3,042
—

Total real estate assets held for sale, net
$
37,508

 
 
Other assets held for sale:
 
Tenant receivables
$
1,747

Prepaid expenses and other assets
39

Intangible lease origination costs, less accumulated amortization of $2,018
—

Deferred lease costs, less accumulated amortization of $242
1,646

Total other assets held for sale, net
$
3,432

 
 
Liabilities held for sale:
 
Accounts payable, accrued expenses, and accrued capital expenditures
$
176

Due to affiliates
2

Deferred income
446

Total liabilities held for sale
$
624

Discontinued Operations
The historical operating results and gains (losses) from the disposition of certain assets, including assets "held for sale" and operating properties sold, are required to be reflected in a separate section ("discontinued operations") in the consolidated statements of operations for all periods presented. As a result, the revenues and expenses of Emerald Point, 5995 Opus Parkway and the Manhattan Towers property are included in income (loss) from discontinued operations in the accompanying consolidated statements of operations for all periods presented. On September 6, 2011, Wells REIT II transferred the Manhattan Towers property, an office building located in Manhattan Beach, California, to an affiliate of its lender in connection with settling a $75.0 million mortgage note through a deed in lieu of foreclosure transaction, resulting in a $13.5 million gain on extinguishment of debt.



Page 22

The following table shows the revenues and expenses of the above-described discontinued operations (in thousands):
 
Three months ended
June 30,
 
Six months ended
June 30,
 
2012
 
2011
 
2012
 
2011
Revenues:
 
 
 
 
 
 
 
Rental income
$
—

 
$
1,264

 
$
89

 
$
2,511

Tenant reimbursements
(124
)
 
304

 
79

 
606

 
(124
)
 
1,568

 
168

 
3,117

Expenses:
 
 
 
 
 
 
 
Property operating costs
4

 
1,430

 
190

 
3,027

Asset and property management fees
—

 
18

 
38

 
49

Depreciation
—

 
699

 
—

 
1,376

Amortization
—

 
232

 
6

 
458

General and administrative
(18
)
 
48

 
(5
)
 
134

Total expenses
(14
)
 
2,427

 
229

 
5,044

Real estate operating loss
(110
)
 
(859
)
 
(61
)
 
(1,927
)
Other expense:
 
 
 
 
 
 
 
Interest expense
—

 
(1,086
)
 
—

 
(2,160
)
Operating loss from discontinued operations
(110
)
 
(1,945
)
 
(61
)
 
(4,087
)
Gain on disposition of discontinued operations
62

 
—

 
16,947

 
—

(Loss) gain from discontinued operations
$
(48
)
 
$
(1,945
)
 
$
16,886

 
$
(4,087
)
10.     Financial Information for Parent Guarantor, Other Guarantor Subsidiaries and Non-Guarantor Subsidiaries
The 2018 Bonds Payable (see Note 5. Bonds Payable) are guaranteed by Wells REIT II and certain direct and indirect subsidiaries of each of Wells REIT II and Wells OP II. On February 3, 2012, in connection with the execution of the $450.0 Million Term Loan, Wells REIT II added two subsidiaries as guarantors to the $450.0 Million Term Loan, the JPMorgan Chase Credit Facility, and the 2018 Bonds Payable, which resulted in the reclassification of prior-period amounts between the guarantor and non-guarantor groupings within the condensed consolidating financial statements to conform with the current period presentation. In accordance with SEC Rule 3-10(d), Wells REIT II includes herein condensed consolidating financial information in lieu of separate financial statements of the subsidiary issuer (Wells OP II) and Subsidiary Guarantors, as defined in the bond indenture, because all of the following criteria are met:
(1)
The subsidiary issuer (Wells OP II) and all Subsidiary Guarantors are 100% owned by the parent company guarantor (Wells REIT II);
(2)
The guarantees are full and unconditional; and
(3)
The guarantees are joint and several.
Wells REIT II uses the equity method with respect to its investment in subsidiaries included in its condensed consolidating financial statements. Set forth below are Wells REIT II's condensed consolidating balance sheets as of June 30, 2012 and December 31, 2011 (in thousands) as well as its condensed consolidating statements of operations (in thousands) for the six month periods ended June 30, 2012 and 2011; its condensed consolidating statements of comprehensive income; and its condensed consolidating statements of cash flows (in thousands), for the six months ended June 30, 2012 and 2011.


Page 23

Condensed Consolidating Balance Sheets (in thousands)
 
As of June 30, 2012
 
Wells
REIT II
(Parent)
 
Wells
OP II 
(the Issuer)
 
Guarantors
 
Non-
Guarantors
 
Consolidating
adjustments
 
Wells
REIT II
(Consolidated)
Assets:
 
 
 
 
 
 
 
 
 
 
 
Real estate assets, at cost:
 
 
 
 
 
 
 
 
 
 
 
Land
$
—

 
$
12,175

 
$
223,522

 
$
468,639

 
$
—

 
$
704,336

Buildings and improvements, net
—

 
62,544

 
1,614,061

 
1,747,873

 
—

 
3,424,478

Intangible lease assets, net
—

 
1,662

 
137,022

 
218,772

 
—

 
357,456

Construction in progress
—

 
575

 
4,879

 
4,405

 
—

 
9,859

Total real estate assets
—

 
76,956

 
1,979,484

 
2,439,689

 
—

 
4,496,129

Cash and cash equivalents
35,916

 
4,475

 
7,423

 
12,804

 
—

 
60,618

Investment in subsidiaries
3,168,212

 
2,685,014

 
—

 
—

 
(5,853,226
)
 
—

Tenant receivables, net of allowance
—

 
3,484

 
61,148

 
69,731

 
(6,448
)
 
127,915

Prepaid expenses and other assets
178,095

 
202,749

 
2,787

 
26,213

 
(380,248
)
 
29,596

Deferred financing costs
—

 
9,904

 
—

 
1,063

 
—

 
10,967

Intangible lease origination costs
—

 
1,117

 
120,631

 
86,398

 
—

 
208,146

Deferred lease costs
—

 
2,116

 
34,670

 
42,609

 
—

 
79,395

Investments in development authority bonds
—

 
60,000

 
466,000

 
120,000

 
—

 
646,000

Total assets
$
3,382,223

 
$
3,045,815

 
$
2,672,143

 
$
2,798,507

 
$
(6,239,922
)
 
$
5,658,766

 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
Line of credit and notes payable
$
—

 
$
507,000

 
$
146,869

 
$
934,004

 
$
(378,592
)
 
$
1,209,281

Bonds payable
—

 
248,552

 
—

 
—

 
—

 
248,552

Accounts payable, accrued expenses, and accrued capital expenditures
1,212

 
10,841

 
22,338

 
40,565

 
(6,448
)
 
68,508

Due to affiliates
—

 
874

 
1,206

 
1,163

 
(1,656
)
 
1,587

Deferred income
—

 
500

 
18,932

 
10,750

 
—

 
30,182

Intangible lease liabilities, net
—

 
—

 
35,517

 
44,789

 
—

 
80,306

Obligations under capital leases
—

 
60,000

 
466,000

 
120,000

 
—

 
646,000

Total liabilities
1,212

 
827,767

 
690,862

 
1,151,271

 
(386,696
)
 
2,284,416

 
 
 
 
 
 
 
 
 
 
 
 
Redeemable Common Stock
151,455

 
—

 
—

 
—

 
—

 
151,455

 
 
 
 
 
 
 
 
 
 
 
 
Equity:
 
 
 
 
 
 
 
 
 
 
 
Total Wells Real Estate Investment Trust II, Inc. stockholders' equity
3,229,556

 
2,218,048

 
1,981,281

 
1,647,236

 
(5,853,226
)
 
3,222,895

Nonredeemable noncontrolling interests
—

 
—

 
—

 
—

 
—

 
—

Total equity
3,229,556

 
2,218,048

 
1,981,281

 
1,647,236

 
(5,853,226
)
 
3,222,895

Total liabilities, redeemable common stock, and equity
$
3,382,223

 
$
3,045,815

 
$
2,672,143

 
$
2,798,507

 
$
(6,239,922
)
 
$
5,658,766






Page 24

Condensed Consolidating Balance Sheets (in thousands)
 
As of December 31, 2011
 
Wells
REIT II
(Parent)
 
Wells
OP II 
(the Issuer)
 
Guarantors
 
Non-
Guarantors
 
Consolidating
adjustments
 
Wells
REIT II
(Consolidated)
Assets:
 
 
 
 
 
 
 
 
 
 
 
Real estate assets, at cost:
 
 
 
 
 
 
 
 
 
 
 
Land
$
—

 
$
—

 
$
223,522

 
$
480,814

 
$
—

 
$
704,336

Building and improvements, net
—

 
—

 
1,635,910

 
1,837,061

 
—

 
3,472,971

Intangible lease assets, net
—

 
—

 
153,070

 
238,919

 
—

 
391,989

Construction in progress
—

 
—

 
4,224

 
4,190

 
—

 
8,414

Real estate assets held for sale
—

 
—

 
—

 
37,508

 
—

 
37,508

Total real estate assets
—

 
—

 
2,016,726

 
2,598,492

 
—

 
4,615,218

Cash and cash equivalents
11,291

 
10,597

 
9,133

 
8,447

 
—

 
39,468

Investment in subsidiaries
3,275,979

 
2,786,248

 
—

 
—

 
(6,062,227
)
 
—

Tenant receivables, net of allowance
—

 
—

 
58,435

 
77,471

 
(5,357
)
 
130,549

Prepaid expenses and other assets
177,444

 
202,126

 
2,056

 
29,009

 
(377,804
)
 
32,831

Deferred financing costs
—

 
8,287

 
—

 
1,155

 
—

 
9,442

Intangible lease origination costs
—

 
—

 
133,052

 
98,286

 
—

 
231,338

Deferred lease costs
—

 
—

 
28,650

 
39,639

 
—

 
68,289

Investments in development authority bonds
—

 
—

 
466,000

 
180,000

 
—

 
646,000

Other assets held for sale
—

 
—

 
—

 
3,432

 
—

 
3,432

Total assets
$
3,464,714

 
$
3,007,258

 
$
2,714,052

 
$
3,035,931

 
$
(6,445,388
)
 
$
5,776,567

 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
Lines of credit and notes payable
$
—

 
$
484,000

 
$
147,730

 
$
966,123

 
$
(376,793
)
 
$
1,221,060

Bonds payable
—

 
248,426

 
—

 
—

 
—

 
248,426

Accounts payable, accrued expenses, and accrued capital expenditures
1,652

 
5,696

 
24,871

 
45,487

 
(5,357
)
 
72,349

Due to affiliates
—

 
2,779

 
1,178

 
383

 
(1,011
)
 
3,329

Deferred income
—

 
—

 
22,280

 
12,799

 
—

 
35,079

Intangible lease liabilities, net
—

 
—

 
39,224

 
50,357

 
—

 
89,581

Obligations under capital leases
—

 
—

 
466,000

 
180,000

 
—

 
646,000

Liabilities held for sale
—

 
—

 
—

 
624

 
—

 
624

Total liabilities
1,652

 
740,901

 
701,283

 
1,255,773

 
(383,161
)
 
2,316,448

 
 
 
 
 
 
 
 
 
 
 
 
Redeemable Common Stock
113,147

 
—

 
—

 
—

 
—

 
113,147

 
 
 
 
 
 
 
 
 
 
 
 
Equity:
 
 
 
 
 
 
 
 
 
 
 
Total Wells Real Estate Investment Trust II, Inc. stockholders' equity
3,349,915

 
2,266,357

 
2,012,769

 
1,779,841

 
(6,062,227
)
 
3,346,655

Nonredeemable noncontrolling interests
—

 
—

 
—

 
317

 
—

 
317

Total equity
3,349,915

 
2,266,357

 
2,012,769

 
1,780,158

 
(6,062,227
)
 
3,346,972

Total liabilities, redeemable common stock, and equity
$
3,464,714

 
$
3,007,258

 
$
2,714,052

 
$
3,035,931

 
$
(6,445,388
)
 
$
5,776,567



Page 25

Consolidating Statements of Operations (in thousands)
 
For the three months ended June 30, 2012
 
Wells
REIT II
(Parent)
 
Wells
OP II
(the Issuer)
 
Guarantors
 
Non-
Guarantors
 
Consolidating
adjustments
 
Wells
REIT II
(Consolidated)
Revenues:
 
 
 
 
 
 
 
 
 
 
 
Rental income
$
—

 
$
2,158

 
$
59,127

 
$
58,365

 
$
(810
)
 
$
118,840

Tenant reimbursements
—

 
191

 
9,807

 
16,168

 
(1,344
)
 
24,822

Hotel income
—

 
—

 
—

 
6,463

 
—

 
6,463

Other property income
—

 
38

 
201

 
417

 
(198
)
 
458

 
—

 
2,387

 
69,135

 
81,413

 
(2,352
)
 
150,583

Expenses:
 
 
 
 
 
 
 
 
 
 
 
Property operating costs
—

 
1,145

 
16,871

 
26,638

 
(1,504
)
 
43,150

Hotel operating costs
—

 
—

 
—

 
5,806

 
(810
)
 
4,996

Asset and property management fees:
 
 
 
 
 
 
 
 
 
 
 
Related-party
8,032

 
48

 
442

 
694

 
(38
)
 
9,178

Other
—

 
—

 
428

 
390

 
—

 
818

Depreciation
—

 
604

 
13,774

 
15,854

 
—

 
30,232

Amortization
—

 
277

 
14,584

 
13,098

 
—

 
27,959

General and administrative
—

 
4,564

 
1,619

 
(388
)
 
—

 
5,795

 
8,032

 
6,638

 
47,718

 
62,092

 
(2,352
)
 
122,128

Real estate operating (loss) income
(8,032
)
 
(4,251
)
 
21,417

 
19,321

 
—

 
28,455

Other income (expense):
 
 
 
 
 
 
 
 
 
 
 
Interest expense
—

 
(8,984
)
 
(10,064
)
 
(14,508
)
 
6,462

 
(27,094
)
Interest and other income
1,997

 
5,367

 
7,307

 
1,803

 
(6,462
)
 
10,012

Loss on interest rate swaps
—

 
—

 
—

 
(13
)
 
—

 
(13
)
Income (loss) from equity investment
16,949

 
22,989

 
—

 
—

 
(39,938
)
 
—

 
18,946

 
19,372

 
(2,757
)
 
(12,718
)
 
(39,938
)
 
(17,095
)
Income (loss) before income tax (expense) benefit
10,914

 
15,121

 
18,660

 
6,603

 
(39,938
)
 
11,360

Income tax expense
—

 
(3
)
 
(51
)
 
(344
)
 
—

 
(398
)
Income (loss) from continuing operations
10,914

 
15,118

 
18,609

 
6,259

 
(39,938
)
 
10,962

Discontinued operations:
 
 
 
 
 
 
 
 
 
 
 
Operating loss from discontinued operations
—

 
—

 
—

 
(110
)
 
—

 
(110
)
Gain on disposition of discontinued operations
—

 
—

 
—

 
62

 
—

 
62

Loss from discontinued operations
—

 
—

 
—

 
(48
)
 
—

 
(48
)
Net income (loss)
10,914

 
15,118

 
18,609

 
6,211

 
(39,938
)
 
10,914

Less: net income attributable to noncontrolling interests
—

 
—

 
—

 
—

 
—

 
—

Net income (loss) attributable to the common stockholders of Wells Real Estate Investment Trust II, Inc.
$
10,914

 
$
15,118

 
$
18,609

 
$
6,211

 
$
(39,938
)
 
$
10,914











Page 26

Consolidating Statements of Operations (in thousands)

 
For the three months ended June 30, 2011
 
Wells
REIT II
(Parent)
 
Wells
OP II
(the Issuer)
 
Guarantors
 
Non-
Guarantors
 
Consolidating
adjustments
 
Wells
REIT II
(Consolidated)
Revenues:
 
 
 
 
 
 
 
 
 
 
 
Rental income
$
—

 
$
—

 
$
59,898

 
$
62,508

 
$
(1,293
)
 
$
121,113

Tenant reimbursements
—

 
—

 
9,646

 
14,919

 
—

 
24,565

Hotel income
—

 
—

 
—

 
5,216

 
—

 
5,216

Other property income
—

 
36

 
377

 
1,755

 
(168
)
 
2,000

 
—

 
36

 
69,921

 
84,398

 
(1,461
)
 
152,894

Expenses:
 
 
 
 
 
 
 
 
 
 
 
Property operating costs
—

 
—

 
17,035

 
27,213

 
(132
)
 
44,116

Hotel operating costs
—

 
—

 
—

 
5,562

 
(1,293
)
 
4,269

Asset and property management fees:
 
 
 
 
 
 
 
 
 
 
 
Related-party
7,690

 
—

 
416

 
1,209

 
(36
)
 
9,279

Other
—

 
—

 
478

 
237

 
—

 
715

Depreciation
—

 
—

 
13,751

 
16,348

 
—

 
30,099

Amortization
—

 
—

 
13,530

 
17,772

 
—

 
31,302

General and administrative
18

 
4,788

 
411

 
1,218

 
—

 
6,435

Acquisition fees and expenses
656

 
—

 
—

 
538

 
—

 
1,194

 
8,364

 
4,788

 
45,621

 
70,097

 
(1,461
)
 
127,409

Real estate operating (loss) income
(8,364
)
 
(4,752
)
 
24,300

 
14,301

 
—

 
25,485

Other income (expense):
 
 
 
 
 
 
 
 
 
 
 
Interest expense
—

 
(12,104
)
 
(10,988
)
 
(11,956
)
 
4,383

 
(30,665
)
Interest and other income (expense)
11

 
4,372

 
7,307

 
2,706

 
(4,383
)
 
10,013

Loss on interest rate swaps
—

 
—

 
—

 
(7,534
)
 
—

 
(7,534
)
Income (loss) from equity investment
3,871

 
14,382

 
—

 
—

 
(18,253
)
 
—

 
3,882

 
6,650

 
(3,681
)
 
(16,784
)
 
(18,253
)
 
(28,186
)
(Loss) income before income tax (expense) benefit
(4,482
)
 
1,898

 
20,619

 
(2,483
)
 
(18,253
)
 
(2,701
)
Income tax (expense) benefit
—

 
—

 
(63
)
 
231

 
—

 
168

(Loss) income from continuing operations
(4,482
)
 
1,898

 
20,556

 
(2,252
)
 
(18,253
)
 
(2,533
)
Discontinued operations:
 
 
 
 
 
 
 
 
 
 
 
Operating loss from discontinued operations
—

 
—

 
—

 
(1,945
)
 
—

 
(1,945
)
Loss from discontinued operations
—


—

 
—

 
(1,945
)
 
—

 
(1,945
)
Net (loss) income
(4,482
)
 
1,898

 
20,556

 
(4,197
)
 
(18,253
)
 
(4,478
)
Less: net income attributable to noncontrolling interests
—

 
—

 
—

 
(4
)
 
—

 
(4
)
Net (loss) income attributable to the common stockholders of Wells Real Estate Investment Trust II, Inc.
$
(4,482
)
 
$
1,898

 
$
20,556

 
$
(4,201
)
 
$
(18,253
)
 
$
(4,482
)


Page 27

Consolidating Statements of Operations (in thousands)
 
For the six months ended June 30, 2012
 
Wells
REIT II
(Parent)
 
Wells
OP II
(the Issuer)
 
Guarantors
 
Non-
Guarantors
 
Consolidating
adjustments
 
Wells
REIT II
(Consolidated)
Revenues:
 
 
 
 
 
 
 
 
 
 
 
Rental income
$
—

 
$
5,681

 
$
117,315

 
$
117,890

 
$
(1,560
)
 
$
239,326

Tenant reimbursements
—

 
344

 
19,708

 
31,905

 
(1,344
)
 
50,613

Hotel income
—

 
—

 
—

 
10,838

 
—

 
10,838

Other property income
—

 
74

 
402

 
2,021

 
(340
)
 
2,157

 
—

 
6,099

 
137,425

 
162,654

 
(3,244
)
 
302,934

Expenses:
 
 
 
 
 
 
 
 
 
 
 
Property operating costs
—

 
2,364

 
33,439

 
53,491

 
(1,610
)
 
87,684

Hotel operating costs
—

 
—

 
—

 
10,653

 
(1,560
)
 
9,093

Asset and property management fees:
 
 
 
 
 
 
 
 
 
 
 
Related-party
16,040

 
134

 
894

 
1,535

 
(74
)
 
18,529

Other
—

 
—

 
880

 
769

 
—

 
1,649

Depreciation
—

 
1,207

 
27,473

 
31,677

 
—

 
60,357

Amortization
—

 
906

 
27,214

 
26,889

 
—

 
55,009

General and administrative
—

 
8,928

 
1,810

 
400

 
—

 
11,138

 
16,040

 
13,539

 
91,710

 
125,414

 
(3,244
)
 
243,459

Real estate operating (loss) income
(16,040
)
 
(7,440
)
 
45,715

 
37,240

 
—

 
59,475

Other income (expense):
 
 
 
 
 
 
 
 
 
 
 
Interest expense
—

 
(17,688
)
 
(20,136
)
 
(29,048
)
 
12,922

 
(53,950
)
Interest and other income
3,994

 
10,733

 
14,614

 
3,609

 
(12,922
)
 
20,028

Loss on interest rate swaps
—

 
—

 
—

 
(89
)
 
—

 
(89
)
Income (loss) from equity investment
54,091

 
66,271

 
—

 
—

 
(120,362
)
 
—

 
58,085

 
59,316

 
(5,522
)
 
(25,528
)
 
(120,362
)
 
(34,011
)
Income (loss) before income tax expense
42,045

 
51,876

 
40,193

 
11,712

 
(120,362
)
 
25,464

Income tax expense
—

 
(14
)
 
(100
)
 
(187
)
 
—

 
(301
)
Income (loss) from continuing operations
42,045

 
51,862

 
40,093

 
11,525

 
(120,362
)
 
25,163

Discontinued operations:
 
 
 
 
 
 
 
 
 
 
 
Operating loss from discontinued operations
—

 
—

 
—

 
(61
)
 
—

 
(61
)
Gains on dispositions of discontinued operations
—

 
—

 
—

 
16,947

 
—

 
16,947

Income from discontinued operations
—

 
—

 
—

 
16,886

 
—

 
16,886

Net income (loss)
42,045

 
51,862

 
40,093

 
28,411

 
(120,362
)
 
42,049

Less: net income attributable to noncontrolling interests
—

 
—

 
—

 
(4
)
 
—

 
(4
)
Net income (loss) attributable to the common stockholders of Wells Real Estate Investment Trust II, Inc.
$
42,045

 
$
51,862

 
$
40,093

 
$
28,407

 
$
(120,362
)
 
$
42,045











Page 28

Consolidating Statements of Operations (in thousands)

 
For the six months ended June 30, 2011
 
Wells
REIT II
(Parent)
 
Wells
OP II
(the Issuer)
 
Guarantors
 
Non-
Guarantors
 
Consolidating
adjustments
 
Wells
REIT II
(Consolidated)
Revenues:
 
 
 
 
 
 
 
 
 
 
 
Rental income
$
—

 
$
—

 
$
118,723

 
$
118,543

 
$
(2,534
)
 
$
234,732

Tenant reimbursements
—

 
—

 
20,192

 
30,280

 
—

 
50,472

Hotel income
—

 
—

 
—

 
9,366

 
—

 
9,366

Other property income
—

 
71

 
495

 
2,052

 
(335
)
 
2,283

 
—

 
71

 
139,410

 
160,241

 
(2,869
)
 
296,853

Expenses:
 
 
 
 
 
 
 
 
 
 
 
Property operating costs
—

 
—

 
34,276

 
51,792

 
(264
)
 
85,804

Hotel operating costs
—

 
—

 
—

 
10,815

 
(2,534
)
 
8,281

Asset and property management fees:
 
 
 
 
 
 
 
 
 
 
 
Related-party
15,236

 
—

 
768

 
2,106

 
(71
)
 
18,039

Other
—

 
—

 
1,055

 
564

 
—

 
1,619

Depreciation
—

 
—

 
27,502

 
30,039

 
—

 
57,541

Amortization
—

 
—

 
28,861

 
32,607

 
—

 
61,468

General and administrative
43

 
9,574

 
1,506

 
1,926

 
—

 
13,049

Acquisition fees and expenses
1,307

 
—

 
—

 
9,913

 
—

 
11,220

 
16,586

 
9,574

 
93,968

 
139,762

 
(2,869
)
 
257,021

Real estate operating (loss) income
(16,586
)
 
(9,503
)
 
45,442

 
20,479

 
—

 
39,832

Other income (expense):
 
 
 
 
 
 
 
 
 
 
 
Interest expense
—

 
(16,013
)
 
(22,008
)
 
(23,484
)
 
8,675

 
(52,830
)
Interest and other income (expense)
2,053

 
8,664

 
14,616

 
5,410

 
(8,675
)
 
22,068

Loss on interest rate swaps
—

 
—

 
—

 
(7,445
)
 
—

 
(7,445
)
Income (loss) from equity investment
12,464

 
34,094

 
—

 
—

 
(46,558
)
 
—

 
14,517

 
26,745

 
(7,392
)
 
(25,519
)
 
(46,558
)
 
(38,207
)
(Loss) income before income tax (expense) benefit
(2,069
)
 
17,242

 
38,050

 
(5,040
)
 
(46,558
)
 
1,625

Income tax (expense) benefit
—

 
—

 
(122
)
 
521

 
—

 
399

(Loss) income from continuing operations
(2,069
)
 
17,242

 
37,928

 
(4,519
)
 
(46,558
)
 
2,024

Discontinued operations:
 
 
 
 
 
 
 
 
 
 
 
Operating loss from discontinued operations
—

 
—

 
—

 
(4,087
)
 
—

 
(4,087
)
Loss from discontinued operations
—


—

 
—

 
(4,087
)
 
—

 
(4,087
)
Net (loss) income
(2,069
)
 
17,242

 
37,928

 
(8,606
)
 
(46,558
)
 
(2,063
)
Less: net income attributable to noncontrolling interests
—

 
—

 
—

 
(8
)
 
—

 
(8
)
Net (loss) income attributable to the common stockholders of Wells Real Estate Investment Trust II, Inc.
$
(2,069
)
 
$
17,242

 
$
37,928

 
$
(8,614
)
 
$
(46,558
)
 
$
(2,071
)




Page 29

Consolidating Statements of Comprehensive Income (in thousands)
 
For the three months ended June 30, 2012
 
Wells
REIT II
(Parent)
 
Wells
OP II
(the Issuer)
 
Guarantors
 
Non-
Guarantors
 
Consolidating
adjustments
 
Wells
REIT II
(Consolidated)
Net income (loss) attributable to the common stockholders of Wells Real Estate Investment Trust II, Inc.
$
10,914

 
$
15,118

 
$
18,609

 
$
6,211

 
$
(39,938
)
 
$
10,914

Market value adjustment to interest rate swap
—

 
(4,016
)
 
—

 
—

 
—

 
(4,016
)
Comprehensive income (loss) attributable to the common stockholders of Wells Real Estate Investment Trust II, Inc.
10,914

 
11,102

 
18,609

 
6,211

 
(39,938
)
 
6,898

Comprehensive income attributable to noncontrolling interests
—

 
—

 
—

 
—

 
—

 
—

Comprehensive income (loss)
$
10,914

 
$
11,102

 
$
18,609

 
$
6,211

 
$
(39,938
)
 
$
6,898

 
For the three months ended June 30, 2011
 
Wells
REIT II
(Parent)
 
Wells
OP II
(the Issuer)
 
Guarantors
 
Non-
Guarantors
 
Consolidating
adjustments
 
Wells
REIT II
(Consolidated)
Net (loss) income attributable to the common stockholders of Wells Real Estate Investment Trust II, Inc.
$
(4,482
)
 
$
1,898

 
$
20,556

 
$
(4,201
)
 
$
(18,253
)
 
$
(4,482
)
Market value adjustment to interest rate swap
—

 
—

 
—

 
(1,579
)
 
—

 
(1,579
)
Comprehensive (loss) income attributable to the common stockholders of Wells Real Estate Investment Trust II, Inc.
(4,482
)
 
1,898

 
20,556

 
(5,780
)
 
(18,253
)
 
(6,061
)
Comprehensive income attributable to noncontrolling interests
—

 
—

 
—

 
4

 
—

 
4

Comprehensive (loss) income
$
(4,482
)
 
$
1,898

 
$
20,556

 
$
(5,776
)
 
$
(18,253
)
 
$
(6,057
)




Page 30

Consolidating Statements of Comprehensive Income (in thousands)
 
For the six months ended June 30, 2012
 
Wells
REIT II
(Parent)
 
Wells
OP II
(the Issuer)
 
Guarantors
 
Non-
Guarantors
 
Consolidating
adjustments
 
Wells
REIT II
(Consolidated)
Net income (loss) attributable to the common stockholders of Wells Real Estate Investment Trust II, Inc.
$
42,045

 
$
51,862

 
$
40,093

 
$
28,407

 
$
(120,362
)
 
$
42,045

Market value adjustment to interest rate swap
—

 
(3,408
)
 
—

 
—

 
—

 
(3,408
)
Comprehensive income (loss) attributable to the common stockholders of Wells Real Estate Investment Trust II, Inc.
42,045

 
48,454

 
40,093

 
28,407

 
(120,362
)
 
38,637

Comprehensive income attributable to noncontrolling interests
—

 
—

 
—

 
4

 
—

 
4

Comprehensive income (loss)
$
42,045

 
$
48,454

 
$
40,093

 
$
28,411

 
$
(120,362
)
 
$
38,641

 
For the six months ended June 30, 2011
 
Wells
REIT II
(Parent)
 
Wells
OP II
(the Issuer)
 
Guarantors
 
Non-
Guarantors
 
Consolidating
adjustments
 
Wells
REIT II
(Consolidated)
Net (loss) income attributable to the common stockholders of Wells Real Estate Investment Trust II, Inc.
$
(2,069
)
 
$
17,242

 
$
37,928

 
$
(8,614
)
 
$
(46,558
)
 
$
(2,071
)
Market value adjustment to interest rate swap
—

 
—

 
—

 
(827
)
 
—

 
(827
)
Comprehensive (loss) income attributable to the common stockholders of Wells Real Estate Investment Trust II, Inc.
(2,069
)
 
17,242

 
37,928

 
(9,441
)
 
(46,558
)
 
(2,898
)
Comprehensive income attributable to noncontrolling interests
—

 
—

 
—

 
8

 
—

 
8

Comprehensive (loss) income
$
(2,069
)
 
$
17,242

 
$
37,928

 
$
(9,433
)
 
$
(46,558
)
 
$
(2,890
)



Page 31

Consolidating Statements of Cash Flows (in thousands)

 
For the six months ended June 30, 2012
 
Wells
REIT II
(Parent)
 
Wells
OP II
(the Issuer)
 
Guarantors
 
Non-
Guarantors
 
Wells
REIT II
(Consolidated)
Cash flows from operating activities:
$
—

 
$
(37,449
)
 
$
96,299

 
$
74,798

 
$
133,648

 
 
 
 
 
 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
 
 
 
 
 
Net proceeds from sale of real estate
—

 
57,747

 
—

 
—

 
57,747

Investment in real estate and related assets
—

 
(2,932
)
 
(12,338
)
 
(15,008
)
 
(30,278
)
Net cash provided by (used in) investing activities
—

 
54,815

 
(12,338
)
 
(15,008
)
 
27,469

 
 
 
 
 
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
 
 
 
 
 
Borrowings, net of fees
—

 
475,888

 
—

 
—

 
475,888

Repayments
—

 
(456,000
)
 
—

 
(34,998
)
 
(490,998
)
Issuance of common stock, net of redemptions and fees
11,466

 
—

 
—

 
—

 
11,466

Distributions
(135,984
)
 
—

 
—

 
(15
)
 
(135,999
)
Intercompany transfers, net
149,143

 
(43,376
)
 
(85,671
)
 
(20,096
)
 
—

Redemption of noncontrolling interest
—

 
—

 
—

 
(301
)
 
(301
)
Net cash provided by (used in) financing activities
24,625

 
(23,488
)
 
(85,671
)
 
(55,410
)
 
(139,944
)
 
 
 
 
 
 
 
 
 
 
Net increase (decrease) in cash and cash equivalents
24,625

 
(6,122
)
 
(1,710
)
 
4,380

 
21,173

Effect of foreign exchange rate on cash and cash equivalents
—

 
—

 
—

 
(23
)
 
(23
)
Cash and cash equivalents, beginning of period
11,291

 
10,597

 
9,133

 
8,447

 
39,468

Cash and cash equivalents, end of period
$
35,916

 
$
4,475

 
$
7,423

 
$
12,804

 
$
60,618




Page 32

Consolidating Statements of Cash Flows (in thousands)

 
For the six months ended June 30, 2011
 
Wells
REIT II
(Parent)
 
Wells
OP II
(the Issuer)
 
Guarantors
 
Non-
Guarantors
 
Wells
REIT II
(Consolidated)
Cash flows from operating activities:
$
953

 
$
(38,398
)
 
$
103,141

 
$
65,331

 
$
131,027

 
 
 
 
 
 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
 
 
 
 
 
Investment in real estate and related assets
(603,000
)
 
—

 
(10,839
)
 
(22,784
)
 
(636,623
)
Net cash used in investing activities
(603,000
)
 
—

 
(10,839
)
 
(22,784
)
 
(636,623
)
 
 
 
 
 
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
 
 
 
 
 
Borrowings, net of fees
—

 
950,485

 
—

 
324,371

 
1,274,856

Repayments
—

 
(659,500
)
 
—

 
(977
)
 
(660,477
)
Issuance of common stock, net of redemptions and fees
26,067

 
—

 
—

 
—

 
26,067

Distributions
(135,100
)
 
—

 
—

 
(20
)
 
(135,120
)
Intercompany transfers
716,867

 
(255,900
)
 
(94,062
)
 
(366,905
)
 
—

Redemptions of noncontrolling interest
—

 
(87
)
 
—

 
—

 
(87
)
Net cash provided by (used in) financing activities
607,834

 
34,998

 
(94,062
)
 
(43,531
)
 
505,239

 
 
 
 
 
 
 
 
 
 
Net increase (decrease) in cash and cash equivalents
5,787

 
(3,400
)
 
(1,760
)
 
(984
)
 
(357
)
Effect of foreign exchange rate on cash and cash equivalents
—

 
—

 
—

 
68

 
68

Cash and cash equivalents, beginning of period
8,281

 
11,074

 
8,250

 
11,277

 
38,882

Cash and cash equivalents, end of period
$
14,068

 
$
7,674

 
$
6,490

 
$
10,361

 
$
38,593


11.
Subsequent Event
In connection with the preparation of its consolidated financial statements and notes thereto included in this report on Form 10-Q, Wells REIT II has evaluated its subsequent events and provided disclosures for such material subsequent events in, among others, Note 4. Lines of Credit and Notes Payable within this filing.
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with our accompanying consolidated financial statements (and notes thereto) and the "Cautionary Note Regarding Forward-Looking Statements" preceding Part I of this report, as well as our consolidated financial statements (and the notes thereto) and Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2011.
Overview
From 2004 through 2010, we raised approximately $5.8 billion in gross equity proceeds and, along with borrowings, invested those proceeds, net of fees, into commercial real estate consisting primarily of high-quality, income-producing office and industrial properties leased to creditworthy entities located in major metropolitan areas throughout the United States. Following our initial growth period, during 2011 and 2012, we have concentrated our efforts on actively managing our assets and exploring a variety of strategic opportunities focused on enhancing the composition of our portfolio and the total return potential for the REIT. In doing so, we have made strategic acquisitions and dispositions and entered into a number of favorable debt transactions, which have given rise to fluctuations in property operating results and interest expense over the periods presented.
Our board of directors and WREF have established a plan to transition our externally-advised management structure to a self-managed platform. The terms of this plan are prescribed in the Transition Service Agreement (“TSA”), effective as of July 1, 2012.  In summary, the TSA requires WREF to transfer the assets and employees necessary to provide the services outlined in the Initial


Page 33

Term Advisory Agreement (see Note 8. Related-Party Transactions and Agreements for additional detail) to WREAS II by January 1, 2013, except as otherwise provided, and includes an option for us to acquire WREAS II during 2013. In consideration for the transition services, we are required to pay WREF a total of $6.0 million in equal monthly payments from July 2012 through June 2013, and to reimburse WREF for half of all related third-party costs incurred up to maximum of $250.0 million. No payment is required, however, to execute our option to acquire WREAS II in 2013 (see Note 8. Related-Party Transactions and Agreements, Future Advisory and Transition Agreements for additional detail).
Liquidity and Capital Resources
Overview
In 2011 and 2012, we actively managed our real estate portfolio with an emphasis on leasing and re-leasing space, and pursuing and closing on strategic acquisitions and selective dispositions to better align our portfolio with our current investment objectives. During this period, we also enhanced our capital structure by continuing to raise net equity proceeds through our DRP, improving the composition, maturities and capacity of our debt portfolio while lowering our overall borrowing costs, accessing new sources of capital, and identifying additional sources of future capital.
In determining how and when to allocate cash resources, we initially consider the source of the cash. We use substantially all net operating cash flows to fund distributions to stockholders. The amount of distributions that we pay to our common stockholders is determined by our board of directors and is dependent upon a number of factors, including the funds available for distribution to common stockholders, our financial condition, our capital expenditure requirements, our expectations of future sources of liquidity, and the annual distribution requirements necessary to maintain our status as a REIT under the Code. When evaluating funds available for stockholder distributions, we consider net cash provided by operating activities, as presented in the accompanying GAAP-basis consolidated statements of cash flows, adjusted to exclude certain costs that were incurred for the purpose of generating future earnings and appreciation in value over the long term, including acquisition fees and expenses. We use DRP proceeds to fund share redemptions (subject to the limitations of our share redemption program), and make residual DRP proceeds available to fund capital improvements for our existing portfolio, additional real estate investments, and other cash needs.
Short-term Liquidity and Capital Resources
During the six months ended June 30, 2012, we generated net cash flows from operating activities of $133.6 million, which consists primarily of receipts from tenants for rent and reimbursements, reduced by payments for operating costs, administrative expenses, and interest expense. During the same period, we paid total distributions to stockholders of $136.0 million, which includes $62.7 million reinvested in our common stock pursuant to our DRP. We expect to use the majority of our future net cash flow from operating activities to fund distributions to stockholders.
During the six months ended June 30, 2012, we sold the 5995 Opus Parkway building and the Emerald Point building for net proceeds of $57.7 million and made net debt repayments of $12.0 million. During this period, we also generated net proceeds from the sale of common stock under our DRP of $62.7 million and used those proceeds, along with cash on hand, to fund share redemptions of $51.3 million and capital expenditures of $30.3 million.
We believe that we have adequate liquidity and capital resources to meet our current obligations as they come due. As of July 31, 2012, we had access to the borrowing capacity under the JPMorgan Chase Credit Facility of $441.5 million.
Long-term Liquidity and Capital Resources
Over the long term, we expect that our primary sources of capital will include operating cash flows, proceeds from our DRP, proceeds from secured or unsecured borrowings from third-party lenders, and, if and when deemed appropriate, proceeds from strategic property sales. We expect that our primary uses of capital will continue to include stockholder distributions; redemptions of shares of our common stock under our share redemption program; capital expenditures, such as building improvements, tenant improvements, and leasing costs; repaying or refinancing debt; and selective property acquisitions, either directly or through investments in joint ventures.
On February 3, 2012, we closed on the $450.0 Million Term Loan, a four-year, unsecured term loan with a syndicate of banks led by JPMorgan Chase Bank N.A., which yielded initial gross proceeds of $375.0 million and additional gross proceeds of $40.0 million in the second quarter for total outstanding borrowings of $410.0 million as of June 30, 2012. The $450.0 Million Term Loan bears interest at LIBOR, plus an applicable base margin; however, we effectively fixed the interest rate (assuming no change in our corporate credit rating) at 2.64% per annum with an interest rate swap executed contemporaneously with the loan. The $450.0 Million Term Loan matures on February 3, 2016 provided that certain conditions are met prior to that date. Furthermore, provided that certain additional conditions are met prior to, and at, maturity, the $450.0 Million Term Loan shall become eligible for a one-year extension upon paying an extension fee equal to 0.15% of the outstanding balance.


Page 34

The Term Loan Accordion Options provided two opportunities to increase total borrowings under the $450.0 Million Term Loan up to a maximum of $450.0 million, both of which have been exercised upon increasing total borrowings from $375.0 million to $410.0 million in April 2012, and increasing total borrowings from $410.0 million to $450.0 million in July 2012. Contemporaneous with the closing each new borrowing, we effectively fixed the interest rate (assuming no change in our corporate credit rating) on each accordion borrowing with an interest rate swap agreement, which together caused the weighted average effective borrowing rate on aggregate borrowings under the $450.0 Million Term loan to decrease slightly from 2.64% per annum to 2.63% per annum. The proceeds from the $450.0 Million Term Loan, including the Term Loan Accordion Options, were used to repay temporary borrowings, and thereby create additional borrowing capacity, under the JPMorgan Chase Credit Facility. The majority of these temporary borrowings were drawn to settle mortgage loans during the second half of 2011 and during 2012.
Consistent with our financing objectives and operational strategy, we continue to maintain low debt levels over the long-term, historically less than 40% of the cost of our assets.  This conservative leverage goal could reduce the amount of current income we can generate for our stockholders, but it also reduces their risk of loss. We believe that preserving investor capital while generating stable current income is in the best interest of our stockholders. Our debt-to-real-estate-asset ratio is calculated using the outstanding debt balance and real estate at cost. As of June 30, 2012, our debt-to-real-estate-asset ratio was approximately 25.6%.
Our board of directors elected to maintain the quarterly stockholder distribution rate at $0.125 per share for the second quarter of 2012. While our operational cash flows from properties remain strong, economic downturns in our markets, or in the particular industries in which our tenants operate, and capital funding requirements for our real estate portfolio, or for future strategic acquisitions, could exert negative pressure on funds available for future stockholder distributions. We are continuing to carefully monitor our cash flows and market conditions and to assess their impact on our future earnings and future distribution projections. Further, as we begin to transition to a self-managed platform and prepare for various liquidity options, we will evaluate the impact that such options would have on our dividend payment policies and may opt to reduce the portion of operating cash to be distributed to stockholders in the future.
Debt Covenants  
Our portfolio debt instruments, the $450.0 Million Term Loan, the JPMorgan Chase Credit Facility, and the unsecured senior notes, contain certain covenants and restrictions that require us to meet certain financial ratios, including the following key financial covenants and respective covenant levels as of June 30, 2012:
 
 
 
 
Actual Performance
 
Covenant Level
 
June 30, 2012
JP Morgan Chase Credit Facility and $450.0 Million Term Loan
 
 
 
Total debt to total asset value ratio
Less than 50%
 
30%
Secured debt to total asset value ratio
Less than 40% 
 
15%
Fixed charge coverage ratio
Greater than 1.75x
 
4.50x
Unencumbered interest coverage ratio
Greater than 2.0x
 
6.48x
Unencumbered asset coverage ratio
Greater than 2.0x
 
3.06x
Unsecured Senior Notes due 2018:
 
 
 
Aggregate debt test
Less than 60%
 
25%
Debt service test
Greater than 1.5x
 
4.79x
Secured debt test
Less than 40%
 
12%
Maintenance of total unencumbered assets
Greater than 150%
 
598%
We were in compliance with all of our debt covenants as of June 30, 2012. Currently, we expect to continue to meet the requirements of our debt covenants over the short and long term.


Page 35

Contractual Commitments and Contingencies
As of June 30, 2012, our contractual obligations will become payable in the following periods (in thousands):
Contractual Obligations
Total
 
2012
 
2013-2014
 
2015-2016
 
Thereafter
Debt obligations
$
1,459,606

 
$
1,192

 
$
130,339

 
$
551,759

 
$
776,316

Interest obligations on debt(1)
391,379

 
33,238

 
123,318

 
100,927

 
133,896

Capital lease obligations(2)
646,000

 
60,000

 
466,000

 
—

 
120,000

Operating lease obligations
227,150

 
2,602

 
5,257

 
5,257

 
214,034

Total
$
2,724,135

 
$
97,032

 
$
724,914

 
$
657,943

 
$
1,244,246

(1) 
Interest obligations on variable-rate debt are measured at the rate at which they are effectively fixed with interest rate swaps agreements (where applicable), a portion of which is reflected as Loss on interest rate swaps in our consolidated statements of operations. Interest obligations on all other debt are measured at the contractual rate. See Item 3. Quantitative and Qualitative Disclosure About Market Risk for more information regarding our interest rate swaps.
(2) 
Amounts include principal obligations only. We made interest payments on these obligations of $20.0 million during the six months ended June 30, 2012, all of which was funded with interest income earned on the corresponding investments in development authority bonds.

Results of Operations
Overview
As of June 30, 2012, we owned controlling interests in 69 office properties, which were approximately 92.2% leased, and one hotel. Our real estate operating results have remained relatively stable for the three and six months ended June 30, 2012, as compared to the same periods in 2011. In the near term, absent future acquisitions or dispositions, we expect future real estate operating income to fluctuate primarily based on leasing activities for our current portfolio.
Comparison of the three months ended June 30, 2011 versus the three months ended June 30, 2012
Rental income was $118.8 million for the three months ended June 30, 2012, which represents a slight decrease as compared to $121.1 million for the three months ended June 30, 2011. Absent changes to our portfolio or the leases currently in place at our properties, future rental income is expected to remain at similar levels in future periods.
Tenant reimbursements and property operating costs remained stable at $24.8 million and $43.2 million, respectively, for the three months ended June 30, 2012, and $24.6 million and $44.1 million, respectively, for the three months ended June 30, 2011. Absent changes to our portfolio or the leases currently in place at our properties, future tenant reimbursements and property operating costs are expected to fluctuate based primarily on leasing activities for our current portfolio.
Hotel income, net of hotel operating costs, was $1.5 million for the three months ended June 30, 2012, which represents an increase as compared to $0.9 million for the three months ended June 30, 2011, primarily due to increased room rates and hotel occupancy. Hotel income and hotel operating costs are primarily driven by the local economic conditions and, as a result, are expected to fluctuate in the future primarily based on changes in the supply of, and demand for, hotel and banquet space in Cleveland, Ohio, similar to that offered by the Key Center Marriott hotel.
Other property income was $0.5 million for the three months ended June 30, 2012, which represents a decrease as compared to $2.0 million for the three months ended June 30, 2011, primarily due to fees earned in connection with lease terminations during the second quarter of 2011. Future other property income fluctuations are expected to primarily relate to future lease restructuring and termination activities.
Asset and property management fees were $10.0 million for the three months ended June 30, 2011 and 2012. Pursuant to the limitations outlined in the Advisory Agreement, monthly asset management fees have been capped at $2.7 million (or $32.5 million annualized) since April 2011 following the March 2011 acquisition of the Market Square Buildings for $603.4 million. Future asset and property management fees are expected to decrease in the near term as a result the new advisory agreements effective July 1, 2012 (see Note 8. Related Party Transactions and Agreements).
Depreciation remained stable at $30.2 million for the three months ended June 30, 2012 and $30.1 million for the three months ended June 30, 2011. Excluding the impact of changes to the leases currently in place at our properties, depreciation is expected to increase in future periods, as compared to historical periods, due to ongoing capital improvements to our properties.


Page 36

Amortization was $28.0 million for the three months ended June 30, 2012, which represents a decrease as compared to $31.3 million for the three months ended June 30, 2011, due to the expiration of in-place leases at several of our properties, partially offset by accelerated amortization for a lease termination effected at 1950 University Circle in the second quarter of 2012 and amortization of deferred leasing costs incurred in connection with the leases executed during the second half of 2011 and the first half of 2012 (approximately 1.9 million square feet). Future amortization is expected to fluctuate primarily based on the expiration of additional in-place leases, offset by amortization of deferred lease costs incurred in connection with recent leasing activity.
General and administrative expenses were $5.8 million for the three months ended June 30, 2012, which represents a decrease as compared to $6.4 million for the three months ended June 30, 2011, primarily due to the resolution of lease-related litigation. Excluding the impact of the litigation settlement, in the near term, future general and administrative expenses are expected to increase due to fees incurred under the Transition Services Agreement effective July 1, 2012 (see Note 8. Related-Party Transactions and Agreements for additional detail).
No acquisition fees were incurred during the three months ended June 30, 2012, as we did not acquire any properties during this period. Acquisition fees and expenses were $1.2 million for the three months ended June 30, 2011, primarily due to the acquisition fees payable to our advisor under the advisory agreement in place during second quarter 2011. Until July 31, 2011, acquisition fees were incurred at 2.0% of gross offering proceeds, subject to certain limitations; effective August 1, 2011, acquisition fees are incurred at 1.0% of the property purchase price (excluding acquisition expenses); however, in no event may total acquisition fees for the 2012 calendar year exceed 2.0% of total gross offering proceeds. As a result of the change, we expect future acquisition fees and expenses to fluctuate based on future acquisition activity.
Interest expense was $27.1 million for the three months ended June 30, 2012, which represents a slight decrease as compared to $30.7 million for the three months ended June 30, 2011, primarily due to lowering our weighted average cost of borrowing upon executing the $450.0 Million Term Loan. Future interest expense will depend largely upon changes in market interest rates and our ability to secure financings or refinancings.
Interest and other income remained stable at $10.0 million for the three months ended June 30, 2011 and 2012. Interest income is expected to remain relatively consistent in future periods given that the majority of this activity consists of interest income earned on investments in development authority bonds, which had a weighted-average remaining term of approximately 5.2 years as of June 30, 2012. Interest income earned on investments in development authority bonds is entirely offset by interest expense incurred on the corresponding capital leases.
We recognized a loss on interest rate swaps that do not qualify for hedge accounting treatment of approximately $13,000 for the three months ended June 30, 2012 compared to $7.5 million for the three months ended June 30, 2011. We anticipate future gains and losses on interest rate swaps that do not qualify for hedge accounting treatment will fluctuate, primarily due to changes in the estimated fair value of our interest rate swaps relative to then-current market conditions. Market value adjustments to swaps that qualify for hedge accounting treatment are recorded directly to equity, and therefore do not impact net income (loss).
Income (loss) from discontinued operations was (approximately $48,000) for the three months ended June 30, 2012 and ($1.9 million) for the three months ended June 30, 2011. As further explained in Note 9. Assets Held for Sale and Discontinued Operations to the accompanying consolidated financial statements, properties meeting certain criterion for disposal are classified as "Discontinued Operations" in the accompanying consolidated statements of operations for all periods presented. For 2011, discontinued operations includes the Manhattan Towers property (transferred to an affiliate of its lender in connection with settling a $75.0 million mortgage note through a deed in lieu of foreclosure transaction in September 2011) and 5995 Opus Parkway and Emerald Point, which sold for total gains of $16.9 million in January 2012; for 2012, discontinued operations includes 5995 Opus Parkway and Emerald Point.
Net income (loss) attributable to Wells REIT II was $10.9 million, or $0.02 per share, for the three months ended June 30, 2012, which represents an increase as compared to ($4.5 million), or $(0.01) per share, for the three months ended June 30, 2011. The increase is primarily attributable a decrease in the losses incurred to mark interest rate swaps to market, a decrease in amortization expense resulting from the expiration of in-place leases, non-recurring losses from discontinued operations related to properties sold in January 2012 and changing the manner in which acquisition fees charged in the third quarter of 2011 from a percentage of equity proceeds raised under the DRP to a percentage of purchase price of properties acquired. Absent the fluctuations in market value of interest rate swaps, we do not expect future net income (loss) to vary materially from current levels. We expect future net income (loss) to fluctuate somewhat based on recent leasing activity and to reflect transition services fees to be incurred under the Transition Services Agreement. Should the U.S. economic recovery remain sluggish, or the U.S. real estate markets remain depressed for a prolonged period of time, the creditworthiness of our tenants and our ability to achieve market rents comparable to the leases currently in place at our properties may suffer and could lead to a decline in net income over the long term.


Page 37

Comparison of the six months ended June 30, 2011 versus the six months ended June 30, 2012
Rental income was $239.3 million for the six months ended June 30, 2012, which represents an increase as compared to $234.7 million for the six months ended June 30, 2011, primarily due to acquiring the Market Square Buildings on March 7, 2011. Absent changes to our portfolio or the leases currently in place at our properties, rental income is expected to remain at similar levels in future periods.
Tenant reimbursements remained stable at $50.6 million for the six months ended June 30, 2012 and $50.5 million for the six months ended June 30, 2011, as additional reimbursements from the Market Square property are offset by fewer reimbursements for the remainder of the portfolio primarily due to concessions offered with new and modified leases executed in 2011 and 2012. Property operating costs were $87.7 million for the six months ended June 30, 2012, which represents an increase as compared to $85.8 million for the six months ended June 30, 2011, primarily due to the acquisition of the Market Square Buildings. Absent changes to our portfolio or the leases currently in place at our properties, future tenant reimbursement fluctuations are generally expected to correspond with future property operating cost reimbursements.
Hotel income, net of hotel operating costs were $1.7 million for the six months ended June 30, 2012, which represents a slight increase as compared to $1.1 million for the six months ended June 30, 2011, due to increased room rates and hotel occupancy primarily in the second quarter of 2012. Hotel income and hotel operating costs are primarily driven by the local economic conditions and, as a result, are expected to fluctuate in the future primarily based on changes in the supply of, and demand for, hotel and banquet space in Cleveland, Ohio, similar to that offered by the Key Center Marriott hotel.
Other property income remained stable at $2.2 million for the six months ended June 30, 2012 as compared to $2.3 million for the six months ended June 30, 2011. Future other property income fluctuations are expected to primarily relate to future lease restructuring and termination activities.
Asset and property management fees were $20.2 million for the six months ended June 30, 2012, which represents an increase as compared to $19.7 million for the six months ended June 30, 2011, primarily due to the acquisition of the Market Square Buildings on March 7, 2011. Pursuant to the limitations outlined in the Advisory Agreement, monthly asset management fees have remained capped at $2.7 million (or $32.5 million annualized) since April 2011 following the March 2011 acquisition of the Market Square Buildings for $603.4 million. Future asset and property management fees are expected to decrease in the near term as a result the new advisory agreements effective July 1, 2012 (see Note 8. Related Party Transactions and Agreements for additional detail).
Depreciation was $60.4 million for the six months ended June 30, 2012, which represents an increase as compared to $57.5 million for the six months ended June 30, 2011, primarily due to the Market Square Buildings acquisition on March 7, 2011. Excluding the impact of changes to the leases currently in place at our properties, depreciation is expected to continue to increase in future periods, as compared to historical periods, due to ongoing capital improvements to our properties.
Amortization was $55.0 million for the six months ended June 30, 2012, which represents a decrease as compared to $61.5 million for the six months ended June 30, 2011, due to the expiration of in-place leases at several of our properties, partially offset by accelerated amortization for a lease termination effected at 1950 University Circle in the second quarter of 2012, and amortization of deferred leasing costs incurred in connection with the leases executed during the second half of 2011 and the first half of 2012 (approximately 1.9 million square feet). Future amortization is expected to fluctuate primarily based on the expiration of additional in-place leases, offset by amortization of deferred lease costs incurred in connection with recent leasing activity.
General and administrative expenses were $11.1 million for the six months ended June 30, 2012, which represents a decrease as compared to $13.0 million for the six months ended June 30, 2011, primarily due to the resolution of lease-related litigation in the second quarter of 2012 and bad debt expense incurred in 2011. Excluding the impact of the litigation settlement, future general and administrative expenses are expected to increase in the near term as a result of fees incurred under the Transition Services Agreement effective July 1, 2012 (see Note 8. Related-Party Transactions and Agreements for additional detail).
Acquisition fees and expenses were $11.2 million for the six months ended June 30, 2011, primarily due to the acquisition of the Market Square Buildings and the acquisition fees charged under the advisory agreement in place in 2011. No acquisition fees were incurred during the six months ended June 30, 2012 as we did not acquire any properties during this period. Until July 31, 2011, acquisition fees were incurred at 2.0% of gross offering proceeds, subject to certain limitations; effective August 1, 2011, acquisition fees are incurred at 1.0% of the property purchase price (excluding acquisition expenses); however, in no event may total acquisition fees for the 2012 calendar year exceed 2.0% of total gross offering proceeds. As a result of the change, we expect future acquisition fees and expenses to fluctuate based on future acquisition activity.


Page 38

Interest expense remained relatively stable at $54.0 million for the six months ended June 30, 2012 as compared to $52.8 million for the six months ended June 30, 2011. Future interest expense will depend largely upon changes in market interest rates and our ability to secure financings or refinancings.
Interest and other income was $20.0 million for the six months ended June 30, 2012, which represents a decrease as compared to $22.1 million for the six months ended June 30, 2011, primarily due to the settlement of litigation in 2011 related to a prospective acquisition that did not close. Interest income is expected to remain relatively consistent in future periods given that the majority of this activity consists of interest income earned on investments in development authority bonds, which had a weighted-average remaining term of approximately 5.2 years as of June 30, 2012. Interest income earned on investments in development authority bonds is entirely offset by interest expense incurred on the corresponding capital leases.
We recognized a loss on interest rate swaps that do not qualify for hedge accounting treatment of approximately $89,000 for the six months ended June 30, 2012 as compared to $7.4 million for the six months ended June 30, 2011. We anticipate future gains and losses on interest rate swaps that do not qualify for hedge accounting treatment will fluctuate, primarily due to changes in the estimated fair value of our interest rate swaps relative to then-current market conditions. Market value adjustments to swaps that qualify for hedge accounting treatment are recorded directly to equity, and therefore do not impact net income (loss).
Income (loss) from discontinued operations was $16.9 million for the six months ended June 30, 2012 as compared to ($4.1 million) for the six months ended June 30, 2011. As further explained in Note 9. Assets Held for Sale and Discontinued Operations to the accompanying consolidated financial statements, properties meeting certain criterion for disposal are classified as "Discontinued Operations" in the accompanying consolidated statements of operations for all periods presented. For 2011, discontinued operations includes the Manhattan Towers property (transferred to an affiliate of its lender in connection with settling a $75.0 million mortgage note through a deed in lieu of foreclosure transaction in September 2011) and 5995 Opus Parkway and Emerald Point, which sold for total gains of $16.9 million in January 2012; for 2012, discontinued operations includes 5995 Opus Parkway and Emerald Point.
Net income (loss) attributable to Wells REIT II was $42.0 million, or $0.08 per share, for the six months ended June 30, 2012, which represents an increase as compared to ($2.1 million), or $0.00 per share, for the six months ended June 30, 2011. The increase is primarily attributable to recognizing non-recurring gains from the sale of 5995 Opus Parkway and Emerald Point in January 2012, incurring non-recurring acquisition fees in connection with acquiring the Market Square Buildings in March 2011, a decrease in the losses incurred to mark interest rate swaps to market, and a decrease in amortization expense resulting from the expiration of in-place leases. Absent the fluctuations in market value of interest rate swaps, we do not expect future net income (loss) to vary materially from current levels. We expect future net income (loss) to fluctuate somewhat based on recent leasing activity and to reflect transition services fees to be incurred under the Transition Services Agreement. Should the U.S. economic recovery remain sluggish, or the U.S. real estate markets remain depressed for a prolonged period of time, the creditworthiness of our tenants and our ability to achieve market rents comparable to the leases currently in place at our properties may suffer and could lead to a decline in net income over the long term.
Funds From Operations and Adjusted Funds From Operations
Funds from Operations ("FFO"), as defined by the National Association of Real Estate Investment Trust ("NAREIT"), is a non-GAAP financial measure considered by some equity REITs in evaluating operating performance. FFO is computed as GAAP net income (loss), adjusted to exclude: extraordinary items, gains (or losses) from property sales (including deemed sales and settlements of pre-existing relationships), depreciation and amortization of real estate assets, impairment losses related to sales of real estate assets, and adjustments for earnings allocated to noncontrolling interests in consolidated partnerships.  Effective December 31, 2011, we adjusted our calculation of FFO to be consistent with NAREIT's recent Accounting and Financial Standards Hot Topics, which clarifies that impairment losses on real estate assets should be excluded from FFO. We believe it is useful to consider GAAP net income, adjusted to exclude the above-mentioned items, when assessing our performance because excluding the above-described adjustments highlights the impact on our operations from trends in occupancy rates, rental rates, operating costs, general and administrative expenses, and interest costs, which may not be readily apparent from GAAP net income alone. We do not, however, believe that FFO is the best measure of the sustainability of our operating performance. Changes in the GAAP accounting and reporting rules that were put into effect after the establishment of NAREIT's definition of FFO in 1999 are resulting in the inclusion of a number of items in FFO that do not correlate with the sustainability of our operating performance (e.g., acquisition expenses, market value adjustments to interest rate swaps, and amortization of certain in-place lease intangible assets and liabilities, among others). Therefore, in addition to FFO, we present Adjusted Funds from Operations ("AFFO"), a non-GAAP financial measure. AFFO is calculated by adjusting FFO to exclude the income and expenses that we believe are not reflective of the sustainability of our ongoing operating performance, as further explained below:



Page 39

•
Additional amortization of lease assets (liabilities). GAAP implicitly assumes that the value of intangible lease assets (liabilities) diminishes predictably over time and, thus, requires these charges to be recognized ratably over the respective lease terms. Such intangible lease assets (liabilities) arise from the allocation of acquisition price related to direct costs associated with obtaining a new tenant, the value of opportunity costs associated with lost rentals, the value of tenant relationships, and the value of effective rental rates of in-place leases that are above or below market rates of comparable leases at the time of acquisition. Like real estate values, market lease rates in aggregate have historically risen or fallen with local market conditions. As a result, management believes that, by excluding these charges, AFFO provides useful supplemental information that is reflective of the performance of our real estate investments, which is useful in assessing the sustainability of our operations.
•
Straight-line rental income. In accordance with GAAP, rental payments are recognized as income on a straight-line basis over the terms of the respective leases. Thus, for any given period, straight-line rental income represents the difference between the contractual rental billings for that period and the average rental billings over the lease term for the same length of time. This application results in income recognition that can differ significantly from the current contract terms. By adjusting for this item, we believe AFFO provides useful supplemental information reflective of the realized economic impact of our leases, which is useful in assessing the sustainability of our operating performance.
•
Loss on interest rate swaps and remeasurement of loss on foreign currency. These items relate to fair value adjustments, which are based on the impact of current market fluctuations, underlying market conditions and the performance of the specific holding, which is not attributable to our current operating performance. By adjusting for this item, we believe that AFFO provides useful supplemental information by focusing on the changes in our core operating fundamentals (rather than anticipated gains or losses that may never be realized), which is useful in assessing the sustainability of our operations.
•
Noncash interest expense. This item represents amortization of financing costs paid in connection with executing our debt instruments, and the accretion of premiums (and amortization of discounts) on certain of our debt instruments.  GAAP requires these items to be recognized over the remaining term of the respective debt instrument, which may not correlate with the ongoing operations of our real estate portfolio. By excluding these items, management believes that AFFO provides supplemental information that allows for better comparability of reporting periods, which is useful in assessing the sustainability of our operations.
•
Real estate acquisition-related costs. Acquisition expenses are incurred for investment purposes (i.e. to promote portfolio appreciation and generation of future earnings over the long term) and, therefore, do not correlate with the ongoing operations of our portfolio. By excluding these items, management believes that AFFO provides supplemental information that allows for better comparability of reporting periods, which is useful in assessing the sustainability of our operations.


Page 40

Reconciliations of net income to FFO and to AFFO (in thousands):
 
Three months ended
June 30,
 
Six months ended
June 30,
 
2012
 
2011
 
2012
 
2011
Reconciliation of Net Income to Funds From Operations and Adjusted Funds From Operations:
 
 
 
 
 
 
 
Net income (loss) attributable to the common stockholders of Wells Real Estate Investment Trust II, Inc.
$
10,914

 
$
(4,482
)
 
$
42,045

 
$
(2,071
)
Adjustments:
 
 
 
 
 
 
 
Depreciation of real estate assets
30,232

 
30,798

 
60,357

 
58,916

Amortization of lease-related costs
27,959

 
31,534

 
55,015

 
61,926

Gain on disposition of discontinued operations
(62
)
 
—

 
(16,947
)
 
—

Total Funds From Operations adjustments
58,129

 
62,332

 
98,425

 
120,842

Funds From Operations
69,043

 
57,850

 
140,470

 
118,771

 
 
 
 
 
 
 
 
Other income (expenses) included in net income, which do not correlate with our operations:
 
 
 
 
 
 
 
Additional amortization of lease assets (liabilities)
(1,421
)
 
314

 
(1,685
)
 
2,105

Straight-line rental income
(36
)
 
(6,665
)
 
(845
)
 
(7,757
)
(Gain) loss on interest rate swaps
(296
)
 
4,962

 
(527
)
 
2,408

Noncash interest expense
988

 
8,632

 
1,897

 
13,988

Subtotal
(765
)
 
7,243

 
(1,160
)
 
10,744

Real estate acquisition-related costs
—

 
1,194

 
—

 
11,220

Adjusted Funds From Operations
$
68,278

 
$
66,287

 
$
139,310

 
$
140,735


Election as a REIT
We have elected to be taxed as a REIT under the Code, and have operated as such beginning with our taxable year ended December 31, 2003. To qualify as a REIT, we must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of our adjusted taxable income, as defined in the Code, to our stockholders, computed without regard to the dividends-paid deduction and by excluding our net capital gain. As a REIT, we generally will not be subject to federal income tax on income that we distribute to our stockholders. If we fail to qualify as a REIT in any taxable year, we will then be subject to federal income taxes on our taxable income for that year and for the four years following the year during which qualification is lost, unless the Internal Revenue Service grants us relief under certain statutory provisions. Such an event could materially affect our net income and net cash available for distribution to our stockholders. However, we believe that we are organized and operate in such a manner as to qualify for treatment as a REIT for federal income tax purposes.
Wells TRS, Wells KCP TRS, and Wells Energy TRS are wholly owned subsidiaries of Wells REIT II and are organized as Delaware limited liability companies and include the operations of, among other things, a full-service hotel. We have elected to treat Wells TRS, Wells KCP TRS, and Wells Energy TRS as taxable REIT subsidiaries. We may perform certain additional, noncustomary services for tenants of our buildings through Wells TRS, Wells KCP TRS, or Wells Energy TRS; however, any earnings related to such services are subject to federal and state income taxes. In addition, for us to continue to qualify as a REIT, we must limit our investments in taxable REIT subsidiaries to 25% of the value of our total assets. Deferred tax assets and liabilities are established for temporary differences between the financial reporting basis and the tax basis of assets and liabilities at the enacted rates expected to be in effect when the temporary differences reverse.
No provisions for federal income taxes have been made in our accompanying consolidated financial statements, other than the provisions relating to Wells TRS and Wells KCP TRS, as we made distributions in excess of taxable income for the periods presented. We are subject to certain state and local taxes related to property operations in certain locations, which have been provided for in our accompanying consolidated financial statements.


Page 41

Inflation
We are exposed to inflation risk, as income from long-term leases is the primary source of our cash flows from operations. There are provisions in the majority of our tenant leases that are intended to protect us from, and mitigate the risk of, the impact of inflation. These provisions include rent steps, reimbursement billings for operating expense pass-through charges, real estate tax and insurance reimbursements on a per-square-foot basis, or in some cases, annual reimbursement of operating expenses above a certain per-square-foot allowance. However, due to the long-term nature of the leases, the leases may not reset frequently enough to fully cover inflation.
Application of Critical Accounting Policies
Our accounting policies have been established to conform with GAAP. The preparation of financial statements in conformity with GAAP requires management to use judgment in the application of accounting policies, including making estimates and assumptions. These judgments affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. If our judgment or interpretation of the facts and circumstances relating to various transactions had been different, it is possible that different accounting policies would have been applied, thus resulting in a different presentation of the financial statements. Additionally, other companies may utilize different estimates that may impact the comparability of our results of operations to those of companies in similar businesses.
Investment in Real Estate Assets
We are required to make subjective assessments as to the useful lives of our depreciable assets. We consider the period of future benefit of the asset to determine the appropriate useful lives. These assessments have a direct impact on net income. The estimated useful lives of our assets by class are as follows:
 
Buildings
  
40 years
 
Building improvements
  
5-25 years
 
Site improvements
  
15 years
 
Tenant improvements
  
Shorter of economic life or lease term
 
Intangible lease assets
  
Lease term
Evaluating the Recoverability of Real Estate Assets
We continually monitor events and changes in circumstances that could indicate that the carrying amounts of the real estate and related intangible assets of both operating properties and properties under construction, in which we have an ownership interest, either directly or through investments in joint ventures, may not be recoverable. When indicators of potential impairment are present that suggest that the carrying amounts of real estate assets and related intangible assets (liabilities) may not be recoverable, we assess the recoverability of these assets by determining whether the respective carrying values will be recovered through the estimated undiscounted future operating cash flows expected from the use of the assets and their eventual disposition. In the event that such expected undiscounted future cash flows do not exceed the carrying values, we adjust the carrying value of the real estate assets and related intangible assets to the estimated fair values, pursuant to the property, plant, and equipment accounting standard for the impairment or disposal of long-lived assets, and recognize an impairment loss. Estimated fair values are calculated based on the following information, in order of preference, depending upon availability: (i) recently quoted market prices, (ii) market prices for comparable properties, or (iii) the present value of future cash flows, including estimated salvage value. Certain of our assets may be carried at more than an amount that could be realized in a current disposition transaction.
Projections of expected future operating cash flows require that we estimate future market rental income amounts subsequent to the expiration of current lease agreements, property operating expenses, the number of months it takes to re-lease the property, and the number of years the property is held for investment, among other factors. The subjectivity of assumptions used in the future cash flow analysis, including discount rates, could result in an incorrect assessment of the property's fair value and could result in the misstatement of the carrying value of our real estate assets and related intangible assets and net income (loss).
Allocation of Purchase Price of Acquired Assets
Upon the acquisition of real properties, we allocate the purchase price of properties to tangible assets, consisting of land and building, site improvements, and identified intangible assets and liabilities, including the value of in-place leases, based in each case on our estimate of their fair values.


Page 42

The fair values of the tangible assets of an acquired property (which includes land and building) are determined by valuing the property as if it were vacant, and the "as-if-vacant" value is then allocated to land and building based on our determination of the relative fair value of these assets. We determine the as-if-vacant fair value of a property using methods similar to those used by independent appraisers. Factors we consider in performing these analyses include an estimate of carrying costs during the expected lease-up periods considering current market conditions and costs to execute similar leases, including leasing commissions and other related costs. In estimating carrying costs, we include real estate taxes, insurance, and other operating expenses during the expected lease-up periods based on current market demand.
Intangible Assets and Liabilities Arising from In-Place Leases where We are the Lessor
As further described below, in-place leases where we are the lessor may have values related to direct costs associated with obtaining a new tenant, opportunity costs associated with lost rentals that are avoided by acquiring an in-place lease, tenant relationships, and effective contractual rental rates that are above or below market rates:
•
Direct costs associated with obtaining a new tenant, including commissions, tenant improvements, and other direct costs, are estimated based on management's consideration of current market costs to execute a similar lease. Such direct costs are included in intangible lease origination costs in the accompanying consolidated balance sheets and are amortized to expense over the remaining terms of the respective leases.
•
The value of opportunity costs associated with lost rentals avoided by acquiring an in-place lease is calculated based on the contractual amounts to be paid pursuant to the in-place leases over a market absorption period for a similar lease. Such opportunity costs are included in intangible lease assets in the accompanying consolidated balance sheets and are amortized to expense over the remaining terms of the respective leases.
•
The value of tenant relationships is calculated based on expected renewal of a lease or the likelihood of obtaining a particular tenant for other locations. Values associated with tenant relationships are included in intangible lease assets in the accompanying consolidated balance sheets and are amortized to expense over the remaining terms of the respective leases.
•
The value of effective rental rates of in-place leases that are above or below the market rates of comparable leases is calculated based on the present value (using a discount rate that reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be received pursuant to the in-place leases and (ii) management's estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining terms of the leases. The capitalized above-market and below-market lease values are recorded as intangible lease assets or liabilities and amortized as an adjustment to rental income over the remaining terms of the respective leases.
Evaluating the Recoverability of Intangible Assets and Liabilities
The values of intangible lease assets and liabilities are determined based on assumptions made at the time of acquisition and have defined useful lives, which correspond with the lease terms. There may be instances in which intangible lease assets and liabilities become impaired and we are required to write-off the remaining asset or liability immediately or over a shorter period of time. Lease restructurings, including lease terminations and lease extensions, may impact the value and useful life of in-place leases. In-place leases that are terminated, partially terminated, or modified will be evaluated for impairment if the original in-place lease terms have been modified. In the event that the discounted cash flows of the original in-place lease stream do not exceed the discounted modified in-place lease stream, we adjust the carrying value of the intangible lease assets to the discounted cash flows and recognize an impairment loss. For in-place lease extensions that are executed more than one year prior to the original in-place lease expiration date, the useful life of the in-place lease will be extended over the new lease term with the exception of those in-place lease components, such as lease commissions and tenant allowances, which have been renegotiated for the extended term. Renegotiated in-place lease components, such as lease commissions and tenant allowances, will be amortized over the shorter of the useful life of the asset or the new lease term.
Intangible Assets and Liabilities Arising from In-Place Leases where We are the Lessee
In-place ground leases where we are the lessee may have value associated with effective contractual rental rates that are above or below market rates. Such values are calculated based on the present value (using a discount rate that reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place lease and (ii) management's estimate of fair market lease rates for the corresponding in-place lease, measured over a period equal to the remaining terms of the leases. The capitalized above-market and below-market in-place lease values are recorded as intangible lease liabilities or assets and amortized as an adjustment to property operating cost over the remaining term of the respective leases.


Page 43

Related Parties
Transactions and Agreements
We have entered into agreements with our advisor, WREAS II, and its affiliates, whereby we pay certain fees and reimbursements to WREAS II or its affiliates, for acquisition fees, asset and property management fees, construction fees, reimbursement of other offering costs, and reimbursement of operating costs. See Note 8. Related Party Transactions and Agreements to our accompanying consolidated financial statements included herein for a discussion of the various related-party transactions, agreements, and fees.
Assertion of Legal Action Against Related-Parties
On March 12, 2007, a stockholder of Piedmont Office Realty Trust, Inc. ("Piedmont REIT") filed a putative class action and derivative complaint, presently styled In re Wells Real Estate Investment Trust, Inc. Securities Litigation, in the United States District Court for the District of Maryland against, among others, Piedmont REIT; Leo F. Wells, III, the Chairman of our Board of Directors; Wells Capital; Wells Management; certain affiliates of WREF; the directors of Piedmont REIT; and certain individuals who formerly served as officers or directors of Piedmont REIT prior to the closing of the internalization transaction on April 16, 2007.
The complaint alleged, among other things, violations of the federal proxy rules and breaches of fiduciary duty arising from the Piedmont REIT internalization transaction and the related proxy statement filed with the SEC on February 26, 2007, as amended. The complaint sought, among other things, unspecified monetary damages and nullification of the Piedmont REIT internalization transaction.
On June 27, 2007, the plaintiff filed an amended complaint, which attempted to assert class action claims on behalf of those persons who received and were entitled to vote on the Piedmont REIT proxy statement filed with the SEC on February 26, 2007, and derivative claims on behalf of Piedmont REIT.
On March 31, 2008, the Court granted in part the defendants' motion to dismiss the amended complaint. The Court dismissed five of the seven counts of the amended complaint in their entirety. The Court dismissed the remaining two counts with the exception of allegations regarding the failure to disclose in the Piedmont REIT proxy statement details of certain expressions of interest in acquiring Piedmont REIT. On April 21, 2008, the plaintiff filed a second amended complaint, which alleges violations of the federal proxy rules based upon allegations that the proxy statement to obtain approval for the Piedmont REIT internalization transaction omitted details of certain expressions of interest in acquiring Piedmont REIT. The second amended complaint seeks, among other things, unspecified monetary damages, to nullify and rescind the internalization transaction, and to cancel and rescind any stock issued to the defendants as consideration for the internalization transaction. On May 12, 2008, the defendants answered and raised certain defenses to the second amended complaint. Since the filing of the second amended complaint, the plaintiff has said it intends to seek monetary damages of approximately $159 million plus prejudgment interest.
On June 23, 2008, the plaintiff filed a motion for class certification. On September 16, 2009, the Court granted the plaintiff's motion for class certification. On September 20, 2009, the defendants filed a petition for permission to appeal immediately the Court's order granting the motion for class certification with the Eleventh Circuit Court of Appeals. The petition for permission to appeal was denied on October 30, 2009.
On April 13, 2009, the plaintiff moved for leave to amend the second amended complaint to add additional defendants. The Court denied the plaintiff's motion for leave to amend on June 23, 2009.
On December 4, 2009, the parties filed motions for summary judgment. On August 2, 2010, the Court entered an order denying the defendants' motion for summary judgment and granting, in part, the plaintiff's motion for partial summary judgment. The Court ruled that the question of whether certain expressions of interest in acquiring Piedmont REIT constituted "material" information required to be disclosed in the proxy statement to obtain approval for the Piedmont REIT internalization transaction raises questions of fact that must be determined at trial.
On November 17, 2011, the court issued rulings granting several of the plaintiff's motions in limine to prohibit the defendants from introducing certain evidence, including evidence of the defendants' reliance on advice from their outside legal and financial advisors, and limiting the defendants' ability to relate their subjective views, considerations, and observations during the trial of the case. On February 23, 2012, the Court granted several of the defendants' motions, including a motion for reconsideration regarding a motion the plaintiff had filed seeking exclusion of certain evidence impacting damages, and motions seeking exclusion of certain evidence proposed to be submitted by the plaintiff. The suit has been removed from the Court's trial calendar pending resolution of a request for interlocutory appellate review of certain legal rulings made by the Court.


Page 44

On March 20, 2012, the court granted the defendants leave to file a motion for summary judgment. On April 5, 2012, the defendants filed a motion for summary judgment.On April 24, 2012, the plaintiff filed its response to the defendants' motion for summary judgment. On May 7, 2012, the defendants filed their reply in support of their motion for summary judgment.  The defendants' motion for summary judgment is currently pending before the court.
Mr. Wells, Wells Capital, and Wells Management believe that the allegations contained in the complaint are without merit and intend to vigorously defend this action. Although WREF believes that it has meritorious defenses to the claims of liability and damages in these actions, WREF is unable at this time to predict the outcome of these actions or reasonably estimate a range of damages, or how any liability and responsibility for damages might be allocated among the 17 defendants in the action, which includes 11 defendants not affiliated with Mr. Wells, Wells Capital, or Wells Management. The ultimate resolution of these matters could have a material adverse impact on WREF's financial results, financial condition, or liquidity.
Commitments and Contingencies
We are subject to certain commitments and contingencies with regard to certain transactions. Refer to Note 6 of our accompanying consolidated financial statements for further explanation. Examples of such commitments and contingencies include:
•
obligations under operating leases;
•
obligations under capital leases;
•
commitments under existing lease agreements; and
•
litigation.
Subsequent Events
In connection with the preparation of our consolidated financial statements and notes thereto included in this report on Form 10-Q, we have evaluated our subsequent events and provided disclosures for such material subsequent event in, among others, Note 4. Lines of Credit and Notes Payable within this report.
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As a result of our debt facilities, we are exposed to interest rate changes. Our interest rate risk management objectives are to limit the impact of interest rate changes on earnings and cash flow primarily through a low to moderate level of overall borrowings. However, we currently have a substantial amount of debt outstanding. We manage our ratio of fixed- to floating-rate debt with the objective of achieving a mix that we believe is appropriate in light of anticipated changes in interest rates. We closely monitor interest rates and will continue to consider the sources and terms of our borrowing facilities to determine whether we have appropriately guarded ourselves against the risk of increasing interest rates in future periods.
Additionally, we have entered into interest rate swaps, and may enter into other interest rate swaps, caps, or other arrangements to mitigate our interest rate risk on a related financial instrument. We do not enter into derivative or interest rate transactions for speculative purposes; however, certain of our derivatives may not qualify for hedge accounting treatment. All of our debt was entered into for other-than-trading purposes.
Our financial instruments consist of both fixed-rate and variable-rate debt. Our variable-rate borrowings consist of the JPMorgan Chase Credit Facility, the $450.0 Million Term Loan, and the Three Glenlake Building mortgage note. However, only the JPMorgan Chase Credit Revolving Facility bears interest at an effectively variable rate, as the variable rate on the $450.0 Million Term Loan and the Three Glenlake Building mortgage note have been effectively fixed through the interest rate swap agreements described below. As of June 30, 2012, we had $97.0 million outstanding under the JPMorgan Chase Credit Facility; $410.0 million outstanding on the $450.0 Million Term Loan; $26.1 million outstanding on the Three Glenlake Building mortgage note; $248.6 million in 5.875% bonds outstanding; and $702.3 million outstanding on fixed-rate, term mortgage loans. The weighted-average interest rate of all of our debt instruments was 4.49% as of June 30, 2012.
On February 3, 2012, we closed on the $450.0 Million Term Loan, a four-year, unsecured term loan with a syndicate of banks led by JPMorgan Chase Bank N.A., which yielded initial gross proceeds of $375.0 million. The $450.0 Million Term Loan bears interest at LIBOR, plus an applicable base margin; however, we effectively fixed the interest rate (assuming no change in our corporate credit rating) at 2.64% per annum with an interest rate swap executed contemporaneously with the loan. The $450.0 Million Term Loan matures on February 3, 2016 provided that certain conditions are met prior to that date. Furthermore, provided that certain additional conditions are met prior to, and at, maturity, the $450.0 Million Term Loan shall become eligible for a one-year extension upon paying an extension fee equal to 0.15% of the outstanding balance.


Page 45

The Term Loan Accordion Options provided two opportunities to increase total borrowings under the $450.0 Million Term Loan up to a maximum of $450.0 million, both of which have been exercised upon increasing total borrowings from $375.0 million to $410.0 million in April 2012, and increasing total borrowings from $410.0 million to $450.0 million in July 2012. Contemporaneous with the closing each new borrowing, we effectively fixed the interest rate (assuming no change in our corporate credit rating) on each accordion borrowing with an interest rate swap agreement, which together caused the weighted average effective borrowing rate on aggregate borrowings under the $450.0 Million Term loan to decrease slightly from 2.64% per annum to 2.63% per annum. The effective interest rate on the $410.0 million outstanding under the $450.0 Million Term Loan as of June 30, 2012 was 2.65%. The proceeds from the $450.0 Million Term Loan, including the Term Loan Accordion Options, were used to repay temporary borrowings, and thereby create additional borrowing capacity, under the JPMorgan Chase Credit Facility. The majority of these temporary borrowings were drawn to settle mortgage loans during the second half of 2011 and during 2012.
During the first quarter of 2012, we used cash on hand and proceeds from the JPMorgan Chase Credit Facility to fully repay the Highland Landmark Building mortgage note of $33.8 million at its maturity. During the six months ended June 30, 2012 and 2011, we made interest payments of approximately $24.5 million and $21.1 million, respectively, related to our line of credit and notes payable.
Approximately $1,360.8 million of our total debt outstanding as of June 30, 2012 is subject to fixed rates, either directly or when coupled with an interest rate swap agreement. As of June 30, 2012, these balances incurred interest expense at an average interest rate of 4.57% and have expirations ranging from 2012 through 2023. A change in the market interest rate impacts the net financial instrument position of our fixed-rate debt portfolio; however, it has no impact on interest incurred or cash flows. The amounts outstanding on our variable-rate debt facilities in the future will largely depend upon the level of investor proceeds raised under our DRP and the rate at which we are able to employ such proceeds in acquisitions of real properties.
We do not believe there is any exposure to increases in interest rates related to the capital lease obligations of $646.0 million at June 30, 2012, as the obligations are at fixed interest rates.
Foreign Currency Risk
We are also subject to foreign exchange risk arising from our foreign operations in Russia. Foreign operations represented 2.0% and 1.9% of total assets at June 30, 2012 and December 31, 2011, respectively, and 2.0% and 0.5% of total revenue for the six months ended June 30, 2012 and 2011, respectively. As compared to rates in effect at June 30, 2012, an increase or decrease in the U.S. dollar to Russian rouble exchange rate by 10% would not materially impact the accompanying consolidated financial statements.
ITEM 4.
CONTROLS AND PROCEDURES
Management's Conclusions Regarding the Effectiveness of Disclosure Controls and Procedures
We carried out an evaluation, under the supervision and with the participation of management, including the Principal Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15(e) under the Securities Exchange Act of 1934 as of the end of the period covered by this report. Based upon that evaluation, the Principal Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report in providing a reasonable level of assurance that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods in SEC rules and forms, including providing a reasonable level of assurance that information required to be disclosed by us in such reports is accumulated and communicated to our management, including our Principal Executive Officer and our Principal Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
There have been no significant changes in our internal control over financial reporting during the quarter ended June 30, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II.
OTHER INFORMATION
ITEM 1.
LEGAL PROCEEDINGS
From time to time, we are party to legal proceedings, which arise in the ordinary course of our business. We are not currently involved in any legal proceedings of which the outcome is reasonably likely to have a material adverse effect on our results of operations or financial condition, nor are we aware of any such legal proceedings contemplated by governmental authorities.


Page 46

ITEM 1A.
RISK FACTORS
The following risk factor should be read together with the risk factors disclosed under Item 1A. of our Annual Report on Form 10-K for the year ended December 31, 2011, which includes a comprehensive discussion of some risks and uncertainties that could cause our actual results to differ materially from those presented in our forward-looking statements.
If you invest in our shares through an IRA or other retirement plan, you may be limited in your ability to withdraw required minimum distributions.
If you establish an IRA or other retirement plan through which you invest in our shares, federal law may require you to withdraw required minimum distributions ("RMDs") from such plan in the future. Any share redemptions requested to satisfy these RMD requirements will be considered requests for "ordinary redemptions," as defined in our share redemption program. Our share redemption program limits the amount of ordinary redemptions that can be made in a given year. As a result, you may not be able to redeem your shares at a time in which you need liquidity to satisfy the RMD requirements under your IRA or other retirement plan. Even if you are able to redeem your shares, such redemptions will be at a price less than the price at which the shares were initially purchased. If you fail to withdraw RMDs from your IRA or other retirement plan, you may be subject to certain tax penalties.
ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(a)
All equity securities sold by us in the quarter ended June 30, 2012 were sold in an offering registered under the Securities Act of 1933.
(b)
Not applicable.
(c)
During the quarter ended June 30, 2012, we redeemed shares as follows (in thousands, except per-share amounts):
Period
 
Total Number
of Shares
Purchased(1)
 
Average Price
Paid per Share
 
Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs(2)
 
Approximate Dollar
Value of  Shares
Available That May
Yet Be Redeemed
Under the Program
April 2012
 
1,291
 
$
6.57

 
1,291
 
(3) 
May 2012
 
1,338
 
$
6.60

 
1,338
 
(3) 
June 2012
 
1,302
 
$
6.66

 
1,302
 
(3) 
During the quarter ended June 30, 2012, we redeemed all of the shares eligible and properly submitted for redemption prior to the redemption payment date in June 2012.
(1) 
All purchases of our equity securities by us in the three months ended June 30, 2012, were made pursuant to our SRP.
(2) 
We announced the commencement of the program on December 10, 2003 and amendments to the program on April 22, 2004; March 28, 2006; May 11, 2006; August 10, 2006; August 8, 2007; November 13, 2008; March 31, 2009; August 13, 2009; February 18, 2010; July 21, 2010; September 23, 2010; July 19, 2011; August 12, 2011; November 8, 2011; and December 12, 2011.
(3) 
We currently limit the dollar value and number of shares that may yet be redeemed under the program. First, we limit requests for redemptions other than those made within two years of a stockholder's death on a pro rata basis so that the aggregate of such redemptions during any calendar year do not exceed 5.0% of the weighted-average number of shares outstanding in the prior calendar year. Requests precluded by this test are not considered in the test below. In addition, if necessary, we limit all redemption requests, including those sought within two years of a stockholder's death, on a pro rata basis so that the aggregate of such redemptions during any calendar year do not exceed the greater of 100% of the net proceeds from our DRP during the calendar year or 5.0% of weighted average number of shares outstanding in the prior calendar year.
ITEM 3.
DEFAULTS UPON SENIOR SECURITIES
(a)
There have been no defaults with respect to any of our indebtedness.
(b)
Not applicable.
ITEM 4.
MINE SAFETY DISCLOSURES
Not applicable.


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ITEM 5.
OTHER INFORMATION
(a)
During the second quarter of 2012, there was no information that was required to be disclosed in a report of Form 8-K that was not disclosed in a report on Form 8-K.
On August 3, 2012, our board of directors approved an amendment and restatement of our bylaws effective as of August 3, 2012. The following changes to the bylaws were made in connection with the amendment and restatement of our charter approved by our stockholders at our annual meeting on July 18, 2012. Section 2.03 of the bylaws was amended to provide that a majority of our outstanding voting stock will be required to call a special meeting of stockholders, as opposed to 10% or more of our outstanding voting stock as previously required. In addition, Article XIII was amended to provide that our board of directors has the exclusive power to adopt, alter, or repeal any provision of the bylaws and to make new bylaws. Previously our stockholders also had this power.
In addition to changes made in connection with the amendment and restatement of our charter, Section 2.02 of the bylaws was also amended to provide that the annual meeting of stockholders will be held on any date determined by the board of directors. Previously the bylaws had provided that the annual meeting of stockholders would be held during the month of July.
(b)
There are no material changes to the procedures by which stockholders may recommend nominees to our board of directors since the filing of our Schedule 14A.
ITEM 6.
EXHIBITS
The exhibits required to be filed with this report are set forth on the Exhibit Index to this quarterly report attached hereto.


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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
WELLS REAL ESTATE INVESTMENT TRUST II, INC.
(Registrant)
 
 
 
 
 
Dated:
August 6, 2012
By:
 
/s/ DOUGLAS P. WILLIAMS
 
 
 
 
Douglas P. Williams
Executive Vice President, Treasurer and
Principal Financial Officer




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EXHIBIT INDEX TO
SECOND QUARTER 2012 FORM 10-Q OF
WELLS REAL ESTATE INVESTMENT TRUST II, INC.
The following documents are filed as exhibits to this report. Exhibits that are not required for this report are omitted.
 
Ex.
Description
3.1 *
Second Amended and Restated Articles of Incorporation.
3.2 *
Amended and Restated Bylaws
4.1
Form of Dividend Reinvestment Enrollment Form (incorporated by reference to Appendix A to the Prospectus included in Post-Effective Amendment No. 7 to the Registration Statement on Form S-11 on Form S-3 (No. 333-144414) and filed with the Commission on August 27, 2010 (the "DRP Registration Statement")).
4.2
Statement regarding restrictions on transferability of shares of common stock (to appear on stock certificate or to be sent upon request and without charge to stockholders issued shares without certificates) (incorporated by reference to Exhibit 4.2 to Amendment No. 2 to the Registration Statement on Form S-11 (No. 333-144414) filed with the Commission on September 22, 2008).
4.3
Amended and Restated Dividend Reinvestment Plan (incorporated by reference to Appendix B to the Prospectus included in the DRP Registration Statement).
4.4
Fifth Amended and Restated Share Redemption Program (incorporated by reference to Exhibit 4.4 to the Company's Current Report on Form 8-K filed with the Commission on December 12, 2011).
10.1 *
Advisory Agreement between the Company and Wells Real Estate Advisory Services II, LLC effective as of April 1, 2012.
10.2 *
Initial Term Advisory Agreement between the Company and Wells Real Estate Advisory Services II, LLC effective as of July 1, 2012.
10.3 *
Transition Services Agreement between the Company, Wells Real Estate Advisory Services II, LLC and Wells Real Estate Funds, Inc. effective as of July 1, 2012.
10.4 *
Investor Services Agreement between the Company and Wells Real Estate Funds, Inc. effective as of July 1, 2012.
10.5 *
Master Property Management, Leasing and Construction Management Agreement between the Company, Wells Operating Partnership II, L.P., and Wells Management Company, Inc. effective as of July 1, 2012.
31.1*
Certification of the Principal Executive Officer of the Company, pursuant to Securities Exchange Act Rules 13a-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*
Certification of the Principal Financial Officer of the Company, pursuant to Securities Exchange Act Rules 13a-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*
Certification of the Principal Executive Officer and Principal Financial Officer of the Company, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS**
XBRL Instance Document.
101.SCH**
XBRL Taxonomy Extension Schema.
101.CAL**
XBRL Taxonomy Extension Calculation Linkbase.
101.DEF**
XBRL Taxonomy Extension Definition Linkbase.
101.LAB**
XBRL Taxonomy Extension Label Linkbase.
101.PRE**
XBRL Taxonomy Extension Presentation Linkbase.

*
Filed herewith.
**
Furnished with this Form 10-Q



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